Understanding the intricacies of a loan is not always easy. Most people know what a loan is and have some general knowledge on the different terms, but may not fully understand the many different intricacies involved.

So over the next few weeks, we are going to go over some of the many aspects of loans. We will cover the general concepts, what to think about when taking out a loan, how to pay off your loan and much more.

We began this series with the general basics of a loan, which you can review in Part 1 of this series. Next we want to focus on specific aspects of loans, particularly interest rates, who benefits from your loan and what it means to get the “right” loan for your situation.

Interest Rates

Interest rates are one of the most important aspects of a loan and directly impact how high or low your monthly payments may be. As we discussed in Part 1, the interest rate is essentially how the lender makes a profit off loaning money to a borrower.

This is why it is important to pay attention to the interest rate of your loan and to shop around for a loans with a lower interest rate. Getting a lower interest rate, especially for a long term loan like a mortgage, can potentially save you thousands of dollars over the life of your loan.

For example, if you were to take out a $10,000 fixed term loan, with a 4.5% interest rate – you would be paying $186.43 a month. If the interest rate were 9%, your monthly payments would rise to $207.58. Over the full life of the loan (5 years), you would be paying an additional $1,269.20 on the loan with a 9% interest rate.

Your credit score and financial history can play a role in determining the terms of your loan. Typically, the better your credit, the more likely the lender is willing to lower the interest rate for your loan. They have more confidence that you have the ability to pay off your loan to completion, so they can take the risk of a lower interest rate. Getting your credit score up before applying for a loan can help ensure that you get an interest rate that works for you over the life of the loan.

Benefits to the Lender

For most lenders, a portion of their revenue associated with your loan comes from the interest you pay over the life of the loan. They can make money off other things, such as closing costs, penalty fees and handling fees, but interest payments is one that can affect you the most. Thus, it is often in the best interest of the lender to lock you into a higher interest rate for a longer term loan. This is why it is important to do research on the different loans that may be available to you, and shop around for the one that offers the best terms for your situation.

If you already have a loan with a high interest rate, the longer you take to pay off this loan, the more the lender collects through interest. This is why it can often be beneficial to try to pay off your loan as fast as you can, assuming there is no penalty for early payoff. Putting extra money towards your loan principal, when you can afford it, is a great way to reduce the amount of “extra” money you are paying towards interest.

The EarnUp Platform can help you do this. It aligns withdrawals with your income schedule to make your full loan payments each month, as well as working to identify opportunities for acceleration. It can help you apply any extra money towards your loan principal to pay off your loan faster.*

The Questions to Ask

Everyone’s financial and personal situation is different, so it becomes important to think about what the “right” loan may be for your situation. You should consider asking yourself a few questions to ensure that you understand the financial commitment you are making:

  • How much money do I actually need?
  • Do I have a plan for paying back this loan?
  • Do I have enough money to cover the monthly payments?
  • Do I really need this loan? Can I make this purchase through saving rather than borrowing?

Questions for the Lender

Once you have properly assessed your financial situation and decided on the type of loan you need, you should prepare yourself with questions to ask your lender when applying for the loan. Below is a list of some questions we think are important to ask:

General Questions

  • What is the interest rate?
  • What is the minimum down payment for this loan?
  • What is my monthly payment amount?
  • What is the term on my loan?
Further Questions

  • Are there any other penalties in my loan?
    • Are there any other possible extra charges that could occur during the term of my loan? Are there “hidden charges” that effectively are penalties?
  • What are the qualifying guidelines for this loan?
  • What documents will I have to provide?
  • How long will it take to process my loan application?
  • What might hold up my approval for this loan?
  • Mortgage: What are the closing costs?
    • Note: Borrowers often pay additional fees at closing for services provided by the lender and other parties, such as a title company.
    • Be aware of these costs, which the lender is required to disclose.

Understanding the importance of interest rates and all other information involving the details of your loan can help you avoid becoming locked into a loan that doesn’t work for your financial situation.

For Part 3, we will dig deeper into the different ways to organize and pay off your loans. And if you have not read Part 1 on the basics of the loan, you can read that here.

 

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*Term reductions are based off the expectation of additional payments made towards the loan principal over the full the life of the loan.

EarnUp blog content is for educational purposes only. Information shown is for illustrative purposes only and is not intended as financial advice. Please consult a financial adviser for advice specific to your financial situation. EarnUp makes no guarantees as to the accurateness, quality, or completeness of the information and EarnUp shall not be responsible or liable for any errors, omissions, inaccuracies in the information or for any user’s reliance on the information.