A guide on applying for loans

Borrowing money is not a small matter and one must consider the entire arrangement and ramifications when they are considering it. When you take out a loan you are entering into a binding agreement, recognised by law, to pay back the loan in monthly increments for a set period of time that can last up to 30 years. 

Depending on the type of loan, a failure to pay the loan could result in repossession, penalties and forfeiture of the security. One way (via monthly payments) or another (repossession, fines, forfeiture of security), there is a significant impact on your finances. You need to consider the fact that while everything around you could change, your obligation to make payments will exist until you have repaid the loan. Your family could grow, as will your bills, but you need to keep your finances in line to make sure you are able to make your payments on time with no deficit.

Taking a prudent approach is the smarter way. This ensures you have a payment plan that is not only manageable; sometimes it could even give you more value in the long run (as you would with a car loan). Here’s a guide explaining the factors to consider before taking out a loan:

Situations where you can consider a loan

Your first step in prudency is to consider whether your specific situation truly warrants a loan. Borrowing is a responsibility and defaulting in payments can have an adverse impact on your credit score and financial reputation. As such, it’s not a good idea to get a loan for a year’s payment term to renovate your bathroom if you can just save the money yourself and then have it done. 

However, there are some situations where a loan might be financially smart. With house prices today, most can’t think of paying the entire amount upfront and mortgages have become an option that is exercised by a majority of “home-owners”. In reality, until your payments are made the bank will own your house and will have the right to repossess the property if you default on your payments. However, until you are making your payments, your rights over the property are intact and you and your family get to enjoy the house from day one.

Buying a car is another situation where a loan would make sense as cars are a depreciating asset. In fact, the second you drive your car off the lot, you start to lose money. Considering this, along with the financing deals that automobile companies and banks offer due to the level of competition, it might just be smarter to lease the car. You can change your car at the end of the payment term on to a renewed lease, without having to pay off the rest of the car.

Loans are also a tool to start or grow a business. If your business truly is growing and a cash injection will truly contribute to that growth then a business loan can be considered. Not only do you get a grace period with such loans, but you also might end up paying a lot less if your business can make all the money back before the grace period expires. Moreover, some banks go as far as to include share ownership as a default consequence rather than repossession or recovery proceedings. If you’re good with your payments, then your business might also gain financial credibility making it easier to conduct business. 

Of course, then there are emergency situations, such as medical bills, emergency surgery, or unexpected death in the family, where you would need to get a loan. There are also situations where getting one loan to pay off all existing loans could be a good idea and necessary to improve financial health or for tax reasons: it all depends on the terms.

Regardless of what your situation is, you need to consider whether it actually is necessary to take out the loan. If you can get the same amount of money by saving up over a relatively short period of time then a loan is not a good idea.

Formalities

As mentioned above, loans are a legally binding agreement and, as such, will involve a number of formalities. Depending on the type of loan, you might need to arrange a number of documents including employment letters, bank statements, credit reports, etc. It also takes a considerable amount of time in getting loan approvals especially if it’s your first loan or if you don’t have the best credit score (explained more below). 

There are some companies, such as Quick Loans, were loans are approvaed quickly, but these loans will not be for a very large amount. The range for such loans usually falls within £1,000 to £20,000, and you might need to give basic information at the very least. Generally, interest rates will be higher too: always speak with a professional before making any decisions.

Budgeting the monthly instalment

Equated Monthly Installments, or EMIs, refer to the monthly payments you will be making towards the repayment of your loan. You can find out what this amount will be before you get the loan so make sure you get quotations for EMIs from multiple lenders. Once you have these quotations, sit down with your monthly budget and figure out how you’re going to make the payment.

You also need to factor the EMI into your savings as you might want to create a small cushion to make monthly payments just in case you aren’t able to make the payment with your monthly income. To be on the safe side, you should make room for three EMI payments in your savings before you apply for the loan. On the other hand, you can work on building that cushion after you take out the loan but doing so might be a little more difficult.

Credit sore: The holy grail of lending

Credit scores are an indicator of one’s financial health and are a numerical representation of a number of different financial factors. These factors include the number of outstanding loans, amount of money lent, amount of money repaid, payment schedule adherence, income, and savings, etc. Incidentally, these are all the factors that lenders also look at individually when they are considering a loan application. A credit score allows for pre-screening and is a mathematical analysis of a person’s reliability when it comes to credit or loan arrangements.

As such, you need to ensure that your credit score has a great rating before you apply for a loan. While a less-than-perfect credit score may not be grounds for rejecting an application, bad credit scores still tend to have an impact on the overall arrangement. A bad credit score usually translates to higher interest rates, which means having to pay hundreds, if not thousands, on top of what you’ve borrowed. A bad credit score could also lead to additional restrictions or securities to be put in place by your lender. Therefore, it is vital that you maintain a healthy credit score.

There are measures you can take if you have a bad credit score like a debt consolidation loan to organise all your loans. With today’s technological advancements, you’ll even find a smartphone app to tell you what accounts to maintain and what investments to make so that your credit score improves.

Interest rates

Despite what marketing by lenders might suggest, loans are in no way a charitable endeavour and lenders make money on lending by the interest rates they charge. You, as the borrower, pay the interest rate for the facility of obtaining a loan. Therefore, the higher your interest rate is, the more you will be paying back to your lender. Short term loans tend to have lower interest rates whereas long term loans have higher interest rates with a variation in the rate after a set period of time like lenders do with mortgages. 

In addition to the term of the loan, your credit rating also has an impact on the interest rate that is charged by lenders. Sometimes there could be other factors as well, which is why it’s important that you speak to your lender in detail and at length to discuss the interest rate. If it is a fixed rate then ensure that the same is written in the contract and that the rate is clearly specified. 

Do your research and talk to a broker

Market research is critical when it comes to loans. The commercial lending sector is filled with intense competition and you’re bound to find a deal that fits your needs perfectly. Whenever you visit a lender, make sure you ask each and every single question that comes to mind. It is the lender’s job to answer your questions and if you’re going to enter into a legally binding agreement for a significant amount of money, you have the right to ask as many questions as you want.

It also helps if you visit your bank first. Having a pre-existing relationship can go a long way in helping you get a loan and the bank will most definitely take the same into consideration when assessing your loan application. You would also be wise in checking the local regulations and laws for commercial lending so you’re aware of your rights as a consumer and taxpayer.

Speaking with a broker can be helpful as they can find borrowing options from a long list of lenders in relatively little time. Also, due to their commercial understanding with these lenders, they could also offer some unique deals. 

Additional factors considered by lenders

In addition to credit scores and income, there are a number of other factors that lenders consider when assessing a loan application. One such factor is age and it affects loan applications in the same way it affects insurance coverage. The restrictions are not as strict as insurance companies, but lenders tend to favour applicants who fall in the 28 to 55-year age limit. In the eyes of the lender, it would be easier for a 32-year old with a steady income to pay back a loan than it would be for a 60-year old with a pension. 

Occupation is another factor, especially when mortgage applications are being considered. Over time, lenders have developed scales on which they are able to judge different professions and occupations in terms of repayment potential. These gauges don’t necessarily bar or prohibit a specific profession or occupation from obtaining a loan, it will have an impact on the amount of money lent, interest rates and repayment terms.  

Finally, as strange as it may seem, lenders also look at the overall work experience of an applicant. This is why you might see “CV” or “resume” under the list of documents to be submitted with a loan application. Work experience is an indication of a person’s professional reliability and stability. Frequency of job changes isn’t a good sign in the eyes of a lender and neither is stagnation. A consistently developed work history with structured growth is what is most preferred by lenders as it shows a willingness to fulfil mandates and meet commitments.

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The material contained in this article is of the nature of general comment only and does not give advice on any particular matter. Recipients should not act on the basis of this article’s information without taking appropriate professional advice.