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Understanding Financial Loans

Personal Loans
Personal Loans
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Whether you’re a savvy borrower or this is your first time thinking about taking out a loan, it’s important to understand how financial loans work to make sure you get the best deal. The majority of banks and lending companies operate fairly and in the customer’s best interest, but knowing what they’re up to provides an extra measure of comfort. Rather than learning the ins and outs of the financial industry, brush up on a few key facts.

Why banks lend money

Helping people meet their monetary goals is a secondary benefit to your lender for making financial loans. Although the interest you pay on loans is an expense to you, lending money is a major portion of the income for banks and other financial institutions. Some loans, like mortgages, are more profitable to the lender because of the size and term, but every loan they make constitutes income as long as you fully repay the loan.

Factors to lending decisions

Depending on the institution, you may know the underwriting guidelines or how they decide to extend credit may be a mystery. Every company follows a different set of internal rules when making financial loans, but the basics generally remain the same across the industry. Your credit score is a major player in the decision because past behavior can be an accurate predictor of future actions. If you have a history of paying your bills on time, they have little cause for concern about your ability to make payments.

High credit scores alone do not guarantee approval. Lenders like to see debt service ratios (DSR) adequate to take on the extra payment load. Simply put, your DSR is an expression of how well your income covers your debt payments. You may also hear this called the debt to income ratio. As a rule, ensure your income is at least twice your credit expense to keep this ratio under control.

Important details for you

Obviously, you want the lowest interest rate possible, but there is more to consider when comparing financial loans. What are the fees? Mortgages usually carry application, title, appraisal and origination fees, while some lines of credit charge an annual fee regardless of use. The lowest interest rate is not always the best deal if the fees are high.

Make sure to ask about repayment terms. Some auto dealerships prefer receiving payments weekly or semi-monthly instead of once per month. This often means making a special trip to make payments instead of mailing checks. It’s also wise to find out if a pre-payment penalty exists. While you are free to take the full loan term, you’ll save on total interest costs by paying off the loan early. Penalties for doing so, however, eat into your savings.

Keep in mind that different types of financial loans carry different underwriting guidelines and terms. Always ask your lender to explain anything unfamiliar to you before signing the paperwork and you’ll be in good shape.


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