To make a smart choice that fits your needs, you should know several key details of any loan you’re considering:
- Loan Type: An installment loan is a type of loan that is paid over time in a set number of payments, such as an auto loan. It has a monthly fixed payment amount. A line of credit or revolving credit is a type of loan that gives the borrower flexibility to decide how much to borrow and when, up to a maximum amount (called a credit limit). Example: a credit card or home equity line of credit (HELOC). This type of loan doesn’t have fixed payments.
- Principal and Interest Amounts: Be clear on how much you’re borrowing (the principal) and the interest rate the lender is charging. Is the interest rate fixed (meaning it doesn’t change) or variable (meaning it—and your payment—can change)? Between the principal and the interest, what will your total cost be over the life of the loan?
- The Payment Schedule: One of the most important details is how much you’ll pay and when. Most loans require monthly payments, some of which go toward repaying the principal and some of which are directed toward interest. It’s important that you make these payments on time each month; otherwise, you’ll face late fees. Late or missed payments will be reflected on your credit report, which could prevent you from getting future loans. You’ll also be charged additional interest if you only make minimum payments on a revolving credit loan.
In exchange for borrowing money, you’ll pay your lender interest—generally a percentage of the amount borrowed. The amount of interest you’ll pay is based on interest rates in the general market, what you’re borrowing the money for, any collateral (property or assets) you pledge and personal factors, such as your credit history.
You’ll want to know a few details about the interest on a potential loan. To compare loans, compare the annual percentage rates (APRs). The APR is the total cost of the loan expressed as an annual percentage. It includes the interest rate, as well as any points, fees or other charges.
Two Types of Interest: Variable and Fixed Rates
With a variable interest rate, the amount you pay in interest can change. For variable-rate loans, your interest rate is generally based on an index rate that changes periodically. If the underlying rate goes up, your payment may increase; if it goes down, your payment may decrease. Your loan documents or credit agreement specify when your rate can change and by how much.
With a fixed rate, you’ll pay a set interest rate regardless of changes in the overall economy. Review your agreement to make sure you understand your payments and when they’re due.
The loan term, or length of the loan, is how long you have to repay it. For instance, if you take out an auto loan, you might have the option of either a 3-year (36-month) or 5-year (60-month) loan.
A longer loan term generally means you’re paying more interest overall, even though your monthly payments are smaller.
Fees and the Fine Print
A lender may charge fees in addition to interest, which can vary based on the type of loan. For example, a mortgage may have different fees than those of a student loan. A lender may charge an application fee to cover the costs of processing your application, such as running a credit check or performing other administrative tasks. The amount charged in fees also varies by lender. Comparing fees, along with interest rates, offered by lenders can help you find the best deal. Learn more about the fees associated with these common loans:
Before you sign on the dotted line, be sure to read all of the loan documents and ask questions about anything you don’t understand. In addition to keeping an eye out for additional fees, be aware of possible penalties and other charges you may encounter if you don’t repay the loan according to the schedule outlined in the agreement. All of these details should be provided in the loan documents you sign.
Finding the right lender is as important as finding the right loan that meets your needs. As you compare potential lenders, consider these qualities of a good lender:
- Clear explanations: Your lender should be able to provide you with information about their loans, the key differences among them, which loans would meet your needs and why you may not qualify for certain products.
- Clear disclosures: You should be able to understand all of the forms you need to complete and documents you need to sign. Your lender should be able to explain what each document means and answer questions about specific points.
- No pressure: Your lender should give you time to review your budget to confirm you can afford the loan, and never pressure you to agree to terms you don’t understand.
- Good service: Your relationship with your lender doesn’t end when the loan is signed—in fact, it’s just the beginning. Choose a lender who offers good customer service (check reviews!) and makes it easy to make payments and view your statements.
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