loan overview

Posted : February 7, 2018
Last Updated : May 15, 2019

loan overview

From buying a car to buying a house, taking out loans can help you achieve the milestones in your life. Use this overview to help you understand the loan process and how to use your credit wisely.

Types of Loans

Consumer Installment Loans
A consumer installment loan is used to pay for personal expenses. Examples are:
  • Auto loans, whereby the automobile you're purchasing is used as collateral for the loan.
  • Unsecured loans for short-term needs, such as buying a computer.

Credit Cards
Credit cards give you the ongoing ability to borrow money for household, family, and other personal expenses.

Having a credit card allows you to buy things without actually having the money right away. Remember that if you are not careful in spending, you can get into big trouble—you could be burdened with debt.

Home Loans
There are three main types of home loans.

Home purchase loans are made for the purpose of buying a house. These loans are secured by the house you’re buying.

A home refinancing loan is a loan that replaces an existing home loan by paying it in full and replacing it with a new home loan. A cash-out refinance loan allows you to borrow more money than owed on the loan to be replaced. Reasons homeowners might want to refinance their home loan include getting:
  • A lower interest rate.
  • Money for home repairs.
  • Money for other personal needs.

Home equity loans allow you to borrow money that is secured by your home. Equity is the value of the home minus the debt or what you owe on the home loan.

If you already have a home mortgage, such as the original home purchase loan, the home equity loan would be a second mortgage also secured by your home. A lender may allow you to borrow up to a certain percentage of your home's value, generally up to 80 percent. These loans can be used for any reason.

The Cost of Credit

Fees are charged by financial institutions for activities such as reviewing your loan application and servicing the account.

A credit card company might charge you an annual maintenance fee of $30, a service fee when you get a cash advance, or a penalty fee for charging over your credit limit. A lender might charge a $30 late fee when you do not pay your bill on time.

Interest is the amount of money a financial institution charges for allowing you to use its money.

The interest rate can be either fixed or variable:
  • Fixed rates stay the same throughout the term of the loan, except in the case of credit cards, where the rate may be changed if the bank gives you required notice.
  • Variable rates might change during the loan term. The loan agreement will show the details of the rate changes.

How Credit Decisions Are Made

When you apply for credit, the lender will review the Four Cs to decide whether you’re a good credit risk, or in other words, whether you’re likely to pay back the loan. These are the Four Cs:
  • Capacity refers to your present and future ability to meet your payments.
  • Capital refers to the value of your assets and your net worth.
  • Character refers to how you’ve paid your bills or debts in the past.
  • Collateral refers to property or assets offered to secure the loan.

Questions to Ask Before Applying for a Loan

Here are some important questions you need to ask yourself before applying for credit:
  • Do I need this?
  • Do I need this now?
  • Can I wait until I have cash to pay for it?
  • Can I get credit?
  • What’s the total cost of the credit, including fees?
  • Can I afford the monthly payments?
  • What’s the APR?

Tips for Managing Your Credit

Once you’ve decided you want to get a loan and have been approved, keep these tips in mind to use the money you’ve borrowed wisely.
  • Try to pay off your entire bill (for credit cards or other lines of credit) each month. If you can’t, paying more than the minimum balance due will reduce finance charges and total interest paid.
  • Pay on time to avoid late fees and protect your credit history. If you can’t pay on time, call your creditor immediately to explain the situation. The creditor may waive the late fees or be willing to make other payment arrangements.
  • Check your monthly statements regularly to verify that they’re accurate. Call your creditor right away if you suspect or identify any errors.
  • Ignore offers creditors may send you to reduce or skip payments. You’ll still be charged finance charges during this period.
  • Think about the cost difference if you purchase your item with cash versus if you purchase your item with credit.

Guard Against Predatory Lending Practices

The best ways to guard against being involved in a predatory loan transaction is to be a good consumer by:
  • Dealing with reputable loan providers.
  • Shopping around with several loan providers of your choice to obtain the best terms.
  • Reading and understanding all terms and conditions of an offered loan or asking questions until you’re sure you understand.
  • Ensuring you can afford and make payments according to the loan terms.

Free Annual Credit Report

You can obtain free annual credit reports by doing one of the following:

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