4 Things to Consider Before Taking a Loan

What to consider before taking out a loan (Source: Pixabay.com)

Getting a loan, irrespective of how small, is a significant financial decision that should not be made lightly. Many people struggling with mountains of debt can trace their woes to an apparently easy loan they took in the past. 

Yet, loans are, as it were, a necessary evil. Emergency savings won’t always be available or sufficient to cover an emergency, an urgent purchase or burgeoning credit card debt, as more than two-thirds of Americans have less than $1,000 as emergency savings. 

You’ll perhaps be a little relieved to know that even the wealthiest people on earth take on debt to exploit the opportunity and accelerate the realization of their financial goals. However, whether it’s truck title loans or student loans, a loan will only work in your favor if you carefully think through it before you submit your application.

  • Determine Why You Need the Money

The reason for taking the loan is the single most important factor. If you don’t get the rationale right, your decision will be a wrong one from the get-go. The reason for the loan can range from a mortgage to a medical bill. 

Once you can clearly articulate why you need the loan, you’ll not only be more persuasive during your interaction with potential lenders but it also lays a good foundation for repayment. For example, if you are seeking a loan to purchase an investment property, then you can develop a roadmap of how the rental income from the property will go towards repaying the loan.

  • What Loan Can You Afford

Determining why you need the loan is one thing—how much loan you can afford is another. This is where things can get dicey. 

First, be careful not to conflate the loan you can afford and the amount of money you need. It’s easy to get fixated on the cause and thus extend the loan’s size and tenure so it can fully cover the cause. 

Second, don’t conflate the loan you qualify for with the loan you can afford. Lenders use a wide range of parameters to determine what loan you qualify for. Nevertheless, a lender is not all-knowing. They can only work with the data at their disposal. Be honest with yourself and take into account future expenses that the lender may not be privy to. 

Don’t extend yourself to the extent that the repayments leave you with hardly any money left for emergency savings. 

  • Know Your Credit Score

Of all the factors the lender will rely on to decide whether to approve your loan application, your credit score and credit history is the most important. It’s the barometer of your financial credibility and repayment reputation. Despite the importance of this metric, a surprising number of adults (3 in every 10) are unaware of their credit score. 

Of course, a poor credit score doesn’t mean you are automatically disqualified for any loan. What it means though is that you can kiss low-interest rates and low repayments goodbye. A poor score depicts you as a high-risk borrower. Lenders have to apply a high-interest rate to cover their bases and reduce their losses if you do default. 

Checking your score before you apply for a loan can also be an opportunity to correct erroneous information in your credit report that could be detrimental to your loan application.

  • Read the Fine Print

Lenders are in business. They aim to maximize their profit as long as they do so without breaking the law. That makes it imperative that you read the fine print before signing the dotted line. 

Pay attention to the annual percentage rate or APR. Some lenders will emphasize that their loan comes with an extremely attractive interest rate but it’s only when you delve into the agreement details that you realize the loan’s APR is prohibitively expensive. Keep an eye on fees such as loan processing fees, prepayment penalties, failed payment fees and late payment fees as some lenders will use these fees to make up for their low-interest rate.

Going through the above checklist before you submit your application will not only improve the odds of your application’s approval but also increases your chances of comfortably repaying the loan.

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