Tips for a Successful Loan Application
Running the numbers
Personal loans typically range from $1,000 to $50,000 or $500 to $100,000.
Forbes Advisor recently surveyed 1,000 US consumers, revealing that more than 80% of Americans borrow less than $20,000. Subsequently, the most common reasons for taking a loan are debt consolidation (22%), covering living expenses (21%), and home improvement (20%.)
A 2021 FDIC Survey on Unbanked and Underbanked Households unveiled that the number of households with personal loans had decreased from 10.8% in 2019 to 8.0% in 2021. Additionally, 72.5% of households in 2019 and 72.3% in 2021 had a personal loan.
According to the Federal Reserve, the average interest rate for a 24-month personal loan was 11.48% in February 2023.
Consumer Affairs states that the average rate on a personal loan is 10-32%.
According to the Motley Fool, new borrowers take out an average of $6,656, while the average loan is $9,896.
How exactly do you apply for a loan?
1. Know your "Why?"
Why do you need a loan?
It could be one of the following reasons:
Covering an unexpected expense
For a significant purchase - a house, car, etc.
Starting a business.
To fund your education (student loan.)
Debt consolidation - using a larger debt to pay smaller debts.
Betting against your investments - something rich people do.
Miscellaneous - weddings, home improvements, medical bills, etc.
Understanding your need for a loan is crucial to examining the rest of it.
2. Create a Budget
After understanding your why, create a budget that evaluates how much you need and have a reasonable (over)estimate for unexpected costs.
You'll also want to mind your debt-to-income (DTI) ratio to determine if you have enough cash flow to sustain new debt. Typically, a DTI of 30-36% is feasible; anything less is much better.
Rule of Thumb: Round each cost to the next $100 and hike your budget by 20-30%; any surplus would be the first instalment towards repaying the debt.
3. Scout for options
Search for different lenders whose options match your needs by inputting relevant info such as your name, address, and income. Lender-searching is now possible through some one-size-fits-all websites that do the weightlifting for you - Bankrate, Experian, Forbes Advisor, and Credit Karma. Just input your basic info, and they'll shortlist your options.
Factors to consider when searching for a loan
Loan Purpose: As explained in "Knowing your Why," consider why you're applying for the loan and gather the lenders specific to your need: the more specific the lenders, the more your options.
Interest Rates: It's important to compare interest rates from different lenders and understand the terms associated with each loan. Defining each term below: i) Interest: Percentage of a loan you'll pay as a fee for borrowing that money. ii) Annual Percentage Rate (APR): The total cost of borrowing money, including interest and fees, expressed as a percentage of the total loan cost. Lenders MUST disclose their APRs on their websites as part of the Truth in Lending Act (TILA) that discloses their interest rates as APRs.
Rule of Thumb: Always consider the APR; it's greater than the interest rate.
Fees: Be mindful of additional fees as listed below: i) Origination Fee: A one-time fee for initiating the loan, usually 1-8% of the loan amount and deducted from it. ii) Prepayment Fee: This is a penalty you'd pay if you pay off a loan too soon. Lenders do this mainly to compensate for the lost interest they would have earned from the loan's entirety; good thing most of them don't do this. iii) Late Payment Fee: Self-explanatory. Usually 1% of the monthly payment or $15, whichever is greater. iv) Returned Payment Fee: A fee charged if a scheduled payment is cancelled because you don't have funds in your bank account. This fee covers the cost of processing the already-cancelled monthly payment.
Note: Interest Rates + Fees = Total cost of the loan. Evaluating this cost will help you rate its affordability.
Loan Amount: AKA the Principal. Chances are that you won't get the exact amount you want because of origination fees, so borrow a little bit more to cover that cost.
Repayment Terms: A term is how long the loan lasts. Also called the period, it's how long you'll take to pay off the loan. Terms vary in 12-month cycles and can go for 12 - 84, lender-dependent. Each term has its monthly instalment, so choose the one that makes sense for you and fits your budget.
Note: Terms and APRs are directly proportional. The longer the term, the higher the APR..and vice versa. Rule of Thumb: Lenders have different loans with different APRs at different monthly payments lasting different terms.
Credit Score: You'll need a decent credit score to apply for a loan. Most lenders will consider a fair score of 630 - 689, with others looking at an excellent score of 690. According to Nerdwallet, the typical minimum credit score to apply for a personal loan is 560-660. Lenders will scrutinize all ends of your credit score (amount of credit, number of accounts, credit history, etc.) to determine your creditworthiness. Thus, the higher your credit score, the better your approval odds and the lesser your interest. Review your credit report for accuracy beforehand, improve it if needed, and apply for your loan.
Lender Reputation and Customer Service: Know your lender before selecting one; read their reviews, analyze their reputation plus customer satisfaction, and gauge their reliability. Considering their customer service standards is vital, as fast and responsive support can ease the loan process. All in all, a reputable lender with excellent customer service guarantees a smooth borrowing experience.
Flexibility: A minor consideration but still pivotal, a loan's flexibility can help you make extra or deferred payments, especially during unforeseen events.
Prequalification: See below.
Depending on how fast you need the cash, the approval and disbursement times can be another decider, and though uncommon, autopay discounts are another.
4. Assess and compare your options
You'll receive multiple options from several lenders depending on your qualifications. Comparing loans among lenders helps you evaluate your choices and determine which fits you best. You'll compare the above-listed factors to choose your preference.
Prequalifying
An ideal way to check if you qualify is by prequalifying - seeing if you qualify for particular loans. Just like you know when the food is ready by tasting it, you know you're eligible for a loan by prequalifying for one. ("Tasting" the loan.)
Prequalifying calculates your loan options, terms, and providers. This way, you decide which lender best suits your needs, the principal you can access, and interest rates, among other factors. The best thing is that prequalifying doesn't hurt your credit score.
Note: Most lenders prequalify their applicants - a difference-maker that filters out those that don't.
Prequalifying helps for three reasons:
The lender soft-checks your credit to determine eligibility without implicating your credit score.
From a soft credit check, you'll know where to improve your credit - amount of credit, history, accounts opened, etc.
A lender that does not prequalify will automatically hard-inquire your credit, denting your credit score, with zero approval guarantees; nothing to gain and everything to lose.
5. Submit your application
After comparing your offers and settling on the most appealing one, finalize and submit your application, ensuring all your info is correct. Sometimes lenders might ask you to clarify some information or request additional documents, so ready yourself for that.
After applying, the lender will perform a hard credit check which will temporarily dink your credit score, regardless of whether they approve or deny your application. Depending on the lender, you'll get your decision within seconds, minutes, or days.
Review the loan agreement
The loan agreement can come immediately before you apply or after they approve you, and it's one that you'll sign electronically. It basically spells out, "This is what you're getting yourself into with this loan." The agreement details your APR, loan term, instalments, penalties, and other information. Upon agreeing, hit "submit."
6. Receive your funds
Once approved (hopefully), you should receive your funds on your lender's stipulated timeline. Approvals range from minutes to hours to days, while disbursements occur within minutes to 24-72 hours after approval.
Ideally, direct deposit is the best way to receive your funds once disbursed, so set that up in advance. If you're not in a rush, mailing a check is another option, though slow and unsafe.
7. Pay it back
Lastly is to pay back the loan as set in the agreement. You can do this either through instalments or lump sums. If you have any loan surplus, use that to start paying it off, and also depending on how long the loan is, include your payments in your monthly budget.
Recall the APR and other fees - they come into play here. About the APR, you must pay off the loan ASAP before interest accrues on your account. About the fees, while most lenders don't have prepayment fees, they might have origination, administration, and late fees, all of which you pay in your adjusted APR.
Automating your payments immensely helps; you always pay on time (racking up your credit score) and might qualify for autopay discounts, lender-dependent.
Carerra's Take
Personally, I'm not a fan of getting into debt in any shape, form, or manner, but times happen when the inevitable happens and getting into debt is a reasonable choice. Plus, there's good debt and bad debt.
Maybe you're moving across the country for a job relocation. Perhaps something tragic happened that your emergency savings aren't enough for. Perchance, you need a short-term student loan to finish your degree.
Whatever you need the debt for, ensure it's for a sensible reason. Have a straight budget, plan to pay it back ASAP, and the rest will work out.
And, of course, not financial advice - do your due diligence and consult an expert for a personalized solution.
All the best,
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~T.K.K
References
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