Know before you Sign!
Here are some loan’ basics to make sure you keep yourself and your business safe.
*Please note that this Article is not to be taken as Financial Advice*
How a Loan is Calculated
A loan amount is based off of a lender’s calculation of risk. This equation is based on the following things:
• employment status
• current debts (think car loan etc)
• assets (i.e. what they can claim if you stop paying)
• credit history
• current credit score
Together these help a lender determine their risk level in lending to you. Simply said as, how much they trust you to be able to pay back the loan with interest in a time-frame that is set by them. Dubious lenders will actually set loans in such a way that they hope you can’t pay back the loan – in this way, you remain in their debt & things can get nasty.
ABC’s of Loan Vocabulary / Jargon
Collateral: Things of value that an individual owns that the bank can lend against such as a house or vehicle. I.e. the collateral on a mortgage is the house.
Personal Loan: A personal loan is given to an individual not a registered business.
A Secured Loan: This type of personal loan is given based on the value of collateral an individual has. It generally has a lower interest rate because the bank considers lending a lower risk because they have the right to seize your assets should you stop paying back the loan.
An Unsecured Loan: This type of personal loan is given even though an individual does not have any collateral or valuable assets. It is considered a higher risk for the lender and as such will usually carry a larger interest rate as a result (although not always).
Debt-to-income ratio: This term contrasts your expenses against your income.
Monthly Payment: This is the amount you will need to pay every month against your loan.
Interest Rate: This is the percentage of interest that is the condition of your loan i.e. you have to pay back more than you lend.
Fixed Rate: This means that the amount of interest you pay stays the same.
Flexible Rate: This means that the amount of interest you pay may change over time.
Loan Term: This is the length of time you have to repay your loan. This can also be flexible or fixed.
Installment Loan: This is a loan that you have a specific amount of months to repay. Your interest rate and monthly payment will stay the same every month.
TAR: TAR stands for Total Amount Repayment.
Tip: Check this TAR figure as it will include all the costs of your loan from start to finish. Plug this figure into your budget to accurately plan.
Default: To stop paying one’s loan. When this happens, a lender has legal right to seize assets and begin legal proceedings to get their money back.
T’s & C’s: The terms and conditions of a loan refer to the fine-print. Know what you are agreeing to.
Minimizing Your Risk as a Borrower
Go over the T’s & C’s in Detail
Don’t take anyone’s word for what the T’s & C’s say. Read them carefully yourself. Go over them with a fine-tooth comb, more than once. Make notes and ask questions about anything you don’t understand. Have someone you trust, who is not involved financially with either party and who is knowledgeable go through the T’s & C’s.
Knowing the T’s & C’s exactly will ensure you uncover any hidden risks that could surprise you later, negatively affecting your budget or ability to repay your loan. Understand what you are agreeing to, you will be bound to the contract until its completion.
Find any Hidden Fees
Sometimes interest with loan repayment isn’t the only added cost of a loan. There may be other fees charged. Some common ones are:
• Origination Fee: This is basically a fee that the lender charges the borrower. It is meant to cover their costs of initiating the loan.
• Prepayment Penalty: This is a counter-intuitive fee. It is an extra amount that you may be charged if you manage to pay your loan off early. It’s important to determine if this applies to your loan and if so how it totals into the cost. Check for this and make sure you include it in your calculations.
Know what a Balloon Payment is and if your loan has one!
A balloon payment is one large payment due at a specific time. They usually come due at the end of the loan term and are often used as a means to keep monthly payment smaller – now read that sentence again.
The existence of a Balloon payment in your loan increases your risk!
Be very careful if you decide upon a loan that contains a balloon payment. If you decide to go ahead, be realistic and budget carefully to ensure that you’ll be able to cover the big payment when it comes due.
What happens if you Default?
If you should fail to make payments, the first thing to do is talk directly with your lender. There is often some grace for missing one monthly payment but do not expect it to continue. The lender might be willing to work with you depending on who they are and what type of loan you have.
Defaulting on a loan can mean losing any assets that are secured against it. At a minimum – it will have a big negative impact on your credit score.
Furthermore, it can leave you dealing with aggressive debt collectors and it may entail costly legal proceedings. Depending on the amount of debt you owe – bankruptcy may occur. Defaulting on your loan should be avoided at all costs as it can curtail your financial future.
Overview of Basic Loan Steps
• Do your research
• Prepare thoroughly
• Present a watertight plan
• Know the fine-print before you sign
Don’t let your potential get curtailed by hidden risks or an unreasonable condition you missed in your loan contract. Even if a loan’s conditions seem fair – can you actually meet them, & in the event that you can’t – could you actually face the consequences & survive!
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