Loans can be tough to get when you’re young. But a strong credit history can keep you in contention.
If you want to do something that costs a lot of money, like starting your own business or making improvements to your home, you’ll probably need a loan to help pay for it. The process of applying for, obtaining, and repaying a loan sometimes described as installment credit—isn’t easy, especially when you’re just starting out. Unlike credit card issuers, lenders won’t be beating down your door to offer you loans. But there are things you can do to make it easier to get a loan—and to pay it off.
APPLYING YOURSELF
When you apply for a loan, you’re judged on many of the same criteria that are used when you apply for a credit card, including your credit score and whether you have a regular job. But since there’s often a lot more money at stake with a loan, you’ll probably find lenders digging deeper into your financial situation.
For example, a lender may ask to see current paystubs or recent income tax returns as evidence of what you earn. But having a bigger income doesn’t automatically make you eligible for a loan. How you handle the income is equally important.
In deciding whether you’ll be able to repay the loan, lenders also look at your net worth. That’s the value of the things you own, including cash, securities, and personal property, minus what you owe on your credit cards or other debts. Lenders will probably ask you to provide this information on a standard form. And they typically ask for the account numbers and balances for whatever bank, brokerage firm, and credit card accounts you have.
Being judged on your net worth can work against you when you’re young. After all, you probably don’t own that much in terms of assets or property, which is why you’re applying for the loan in the first place. But if you’re investing for retirement with a 401(k) or you’ve opened an IRA—which you should be doing anyway—the money you’ve invested can help strengthen your financial position. While lenders can’t dip into your retirement accounts to cover your loans, they usually include the amounts as part of your assets. That should give your application a boost.
WHAT A LOAN COSTS
When you’re shopping for a loan, check the total cost. While the principal, or the amount you borrow, and the interest you pay are very important, you’ve got to look at other factors as well. The term of the loan, and the fees you pay for applying and for having your credit checked are also crucial.
A loan’s annual percentage rate (APR) helps you compare costs because the APR takes into account the fees you pay to arrange the loan, as well as the annual interest charges. That gives you an accurate picture of what you’ll actually pay to borrow.
Interest rates, and therefore APRs, vary widely, and are significantly lower in some periods than others. A drop or increase in rates reflects what’s happening in the economy as a whole, and whether borrowing overall is relatively cheap or quite expensive. What doesn’t change, whatever the rates are, is that you want the lowest APR you can find.
Of course, on a $10,000 loan that you’ll repay over three or four years, it doesn’t work out to a very big difference in your monthly payments. But if you ever take a mortgage, where you’ll be paying many tens (or hundreds) of thousands of dollars over 30 years, an extra 0.35% or 0.50% means you’ll be paying a lot more money.
Lenders are required by law to tell you a loan’s APR in their advertising, which means you can compare different loans on equal terms without having to do any of the figuring on your own.
BORROWED TIME
The term of a loan is an important factor in keeping your cost as low as possible. While a shorter term means that you’ll be making fewer, but larger payments, it also means that you’ll be paying interest for fewer years. That brings your total cost down. So $10,000 you borrow at 10% would cost you $322.68 per month on a three-year loan, $253.63 on a four-year loan, and $212.48 on a five-year loan. But the total cost with the three-year loan would be about $11,590—instead of more than $12,700 after five years.
FIRST THINGS FIRST
When you start paying back a loan, every payment you make pays off a certain portion of the interest and
a certain portion of the principal. Banks and most other commercial lenders front-load their interest so that they can maximize their profit. Since you’re paying mostly interest at first, it takes a substantial amount of time to begin reducing your principal.
Amortization is another word for the process of paying off a long-term loan. It comes from the French verb for “to bring to death.” Although you might feel like you’re the one dying after a few years of payments, it’s the loan that’s being amortized.
