Loans can have many functions, at the most basic level they provide more money, funds which can then be used for numerous purposes. A loan can help people accomplish some of their life goals such as getting a higher education, owning a home, getting a vehicle (or other vehicle), travelling to new and exotic locations, consolidating and paying down other debt, or helping family members with their financial needs. Yet a loan is also a significant ongoing expense and an important financial responsibility that affects your personal finances and may strongly affect your credit report and credit score for several years.
Whether it’s a personal, business, vehicle (or other vehicle), mortgage, vacation, holiday or some other kind of loan, as with many things in life, they come with serious obligations and added costs. When thinking about a loan and approaching a list of lender candidates, it’s important to research your lender and to familiarize yourself with the basics of lending and a loan agreement, such as interest rates, terms and repayment conditions. Be prepared with questions to ask so that you will understand precisely what you are offered. When meeting with a lender, the following are some of the essential questions to think about and explore both prior to and during your lender discussions.
The information below was based on input from Delta Community loan specialists, the credit reporting agency Experian®, the federal agency Consumer Financial Protection Bureau, the U.S. government agency Federal Trade Commission and the non-profit Money Management International®.
Key questions to ask when considering taking out a loan
How does a strong credit report and high credit score impact the terms of my loan? Most lenders underwrite and price loans based on the potential risk associated with a borrower. Therefore, the stronger your credit report and the higher credit score can typically lead to more favorable interest rates and terms. Financial factors such as length of credit history, payments history, existing debt, current amount of credit provided (such as from a credit card issuer) and other information may all impact your credit score. Here’s some background information on credit reports and scores to consider:
The three major national credit reporting companies (also known as agencies or bureaus) in the United States are Equifax®, Experian™ and TransUnion LLC, and they continuously collect your personal financial information from other companies (credit card issuers, insurers, landlords, stores, etc.) to compile a personal credit report. The credit report is a summary of monetary activities which gives you a financial reputation; with a credit score it helps define your creditworthiness. Along with your credit report, your personal credit history creates a related piece of essential financial data known as a credit score. A credit score is a single number, within a numerical ranking from low to high, that summarizes your entire credit history into an overall rating similar to poor, fair, good, very good and excellent. The actual number ranges usually start at 300 and go up to 850. A good credit report and score demonstrate consistent payment and credit history and a manageable debt level that lenders rely on when evaluating potential borrowers .
You should understand that there are many different versions of credit scores in the market and the credit score may vary by the credit reporting agency used by the lender. Often the credit score from the free credit score information available may not be the same score used by your lender.
According to U.S. law, consumers have been entitled to obtain one free credit report annually from each of the top three national credit reporting companies mentioned above. However, the three companies have permanently extended a program that lets you check your credit report from each of them once a week for free at annualcreditreport.com. To request a copy of a credit report, go online to that site and follow its instructions to request a report, or call 1-877-322-8228. That site—and only that site—is authorized by the federal government to provide free credits reports. The credit agencies will often sell consumers details on their credit scores, but some may provide it at no cost under certain circumstances (such as with a free, limited trial of a paid service), so contact each of the top three agencies for specific information on how they are willing to provide your credit details.
How much do I want to borrow, and can I afford to repay the loan? If you’re looking for a loan, you should already know exactly what it will be used for and the amount needed to accomplish the purpose of these additional funds. You should also be quite certain that you have analyzed your yearly household budget and are financially able to afford monthly loan payments, both now and for the length of the loan—including being able to repay the loan and manage unforeseen occurrences requiring more money, such as medical, vehicle or home repair expenses. If you need help projecting your costs and understanding how much of a loan you can reasonably handle, you should talk with financial institutions’ loan officers or get independent, free advice from local or national financial counseling organizations.
Have I made a commitment to rigorously shop around for the optimal loan for my needs? Credit unions, banks, brokerage firms and specialized lenders all offer different types of loans with varying interest rates, terms (the set length of time for the loan to be paid back), fees, charges and many other conditions. It is extremely important to review the contractual conditions of a loan offer for anything that you want to avoid, such as a mandated early repayment financial penalty, or a varying interest rate that could significantly increase at some future time due to certain circumstances changing, such as higher U.S. Federal Reserve Bank interest rates or because of a missed payment. A consumer may want to create a chart or a spreadsheet comparing how different loan offers are similar or different to get a more precise understanding of what may be the best overall loan for their specific situation.
What’s the annual percentage rate (APR) and the interest rate for the loan and will the interest rate change at any time? Almost all loans have interest, a certain percentage of the total loan amount that’s paid back to the lender (in addition to the loan amount, or principal) that provides a profit on the loan to the lender. The annual percentage rate usually reflects both the interest rate and certain fees which will be paid by the borrower. Some lenders may offer a low interest rate but compensate for the reduced rate by having higher charges and fees. Since the APR incorporates both interest and most fees, this is the key rate that a borrower should compare to determine which lender offers the best deal.
It’s also crucial to decide if you’re looking for a fixed-rate loan with an interest rate that is locked in and unchangeable, or a variable rate that could fluctuate and either decrease or increase depending on criteria in the loan agreement. With a fixed-rate loan, the interest rate and total monthly cost is predictable and easy to plan for, while with a variable-rate loan there may be some amount of uncertainty about what the monthly payment will be.
Besides the principal, how much total interest will I pay over the term of the loan? A lender should clearly present the information in writing on the total cost of repaying the loan and its interest, and the applicant should clearly understand what the interest is for the overall life term of the loan.
For how long is the current loan offer valid? After discussion (and maybe negotiation), you have a firm loan offer, which should be evaluated thoroughly and compared with any other offers you may have in hand. But how long is the offer good for? Does it expire after a certain time period and are you feeling pressure to accept it? Maybe interest rates are fluctuating or there is some other reason that might persuade you to move quickly on it. However, most potential borrowers should have sufficient time to review and consider their loan offer. A mortgage preapproval letter (or offer) may typically stay open only for a fixed amount of time (as just one example, for 30 days), which should be enough time to obtain and compare offers from different lenders. Other types of loan approval offers—such as for personal or vehicle loans—vary somewhat from mortgage deadlines, but often may be available for acceptance for approximately 30 days after the offer is made. Be wary of any lender that provides a limited acceptance time period shorter than standard timeframes; any loan activity that differs substantially from industry and market norms should be clearly and completely explained by a lender, and you should be prepared to question the lender’s justification for what appears to be any unusual policy or procedure.
This concludes Essential Questions to Ask About a Loan – Part 1.
Part 2 of this post continues on the blog in a few weeks.
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