03 Jun Understanding Different Loan Types
Saving up money before investing is always a wise move when you are going to buy something big. Unfortunately, in reality, many people find that impossible. It is very important to budget for the big expenses, such as a college education, a car, or a home, as well as unexpected emergencies, such as medical expenses.
A loan is an option if you cannot save money in advance. Whenever you are making a purchase, you should consider what kind of loan you should apply for because certain loans are meant for specific items.
Today, loans can be used for a wide variety of things, from funding startups to buying appliances for a newly purchased home. You can even apply for bank loans online. This article discusses a few types of loans available on the market and how they can be beneficial for different types of clients based on their specific needs.
What Is a Bank Loan?
Loans are forms of credit taken on by individuals or corporations. A bank loan is the most common form of loan capital for a business. Bank loans are used to provide medium-term or long-term financing for businesses. The bank specifies the terms, interest rates, and repayment schedule as part of the loan agreement.
Loans from banks are commonly used to finance part of the startup capital and finance large and long-term purchases. Suppose a bank is considering lending money to a startup company. In that case, the bank is likely to request that the business provide collateral for the loan. However, in the case of a startup, this security is usually in the form of personal guarantees provided by the entrepreneur.
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Different Types of Bank Loans
There are many types of bank loans available on the market. It is important to note that different factors can affect the cost and terms of the contractual agreement and the costs associated with them.
Home loans are secured loans obtained from a bank, a financial establishment, or some other financial institution to realize a dream and buy a house. These loans offer fixed or floating interest rates. The loan repayment period is a specified period, and an installment is made every month over the set period. A loan can be used to purchase either residential or commercial property.
In a home equity loan, your home serves as collateral to secure the loan, allowing you to borrow a lump sum amount of money using your equity. To qualify to borrow the maximum amount, you need to have equity in your home or have the difference between its market value and how much you owe on it. If you have equity in your home, you are usually not allowed to borrow more than 85% of that equity.
The auto loan is a secured loan that you can use to buy a car with a repayment term ranging between three and seven years. As collateral for the loan, the car is used as security. In the case of nonpayment, the lender will repossess the car.
Auto loans are typically available from credit unions, banks, online lenders, and even car dealerships. Dealerships sometimes have a finance department that helps you find the right loan through their lending partners.
Generally, personal loans fall into the broadest category of loans. Usually, they offer a repayment period between 24 and 84 months, depending on the nature of the loan. In fact, they can be used for almost any purpose for the most part, except for paying for college educations and illegal activities. A personal loan is commonly used for emergency expenditures such as medical treatment, home renovations, consolidating debt, etc.
There are two main types of personal loans: secured and unsecured loans. The loan application process for a personal loan is surprisingly easy. It can usually be done either through a bank, credit union, or online lender. To qualify for the best personal loans, borrowers with excellent credit must be able to qualify for low-interest rates and a variety of repayment options.
A student loan is a financial aid program designed to pay for tuition, fees, and living expenses at accredited schools. Generally, student loans cannot be used to pay for specific types of education, such as coding boot camps courses or informal classes.
Student loans can be categorized into two types: federal and private. If you want to get a federal student loan, you need to fill out the Free Application for Federal Student Loans (FAFSA) and work with the financial aid department at your school. Federal student loans generally provide more protections and benefits to borrowers. Still, their interest rates are slightly higher than those of private student loans. The private student loan comes with much fewer protections and benefits than government loans. However, if your credit is good, you may be able to qualify for lower interest rates.
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How Do Loans Work
A loan is an agreement in which you (the borrower) will receive money from a lender. In exchange, you will repay the borrowed amount, along with interest, over a defined period. Every loan is governed by a contract between the lender and the borrower, which establishes the loan’s terms. A secured loan is where the borrower can put up an asset as collateral (like a house or a car). As a result, the lender feels more confident about the loan. The lender takes on greater risk when making an unsecured loan since it does not have collateral.
Applying for a Bank Loan
Applying for a bank loan can seem overwhelming if you haven’t done it before, especially if you’ve never done this before. The steps below will walk you through the process.
See if You Qualify
You need to know whether you qualify for a bank loan before applying. Generally, applicants with good to excellent credit (690 or higher on the FICO scale) are accepted by most banks; however, some banks accept applicants with fair credit (630 to 689 FICO).
Also, your debt-to-income ratio may be a consideration. Whether you can handle new debt – DTI is typically capped at 40%, but lower is better.
A pre-qualification with the bank is the best way to determine your eligibility. To pre-qualify, you fill out a preliminary application to determine what rate, loan amount, and repayment term you might qualify for. You won’t be negatively impacted by pre-qualifying.
However, not all banks offer this option. Call your bank’s customer service and ask what the requirements are if your bank doesn’t. If a minimum credit score or income requirement exists, get as much information as you can.
You cannot apply for a personal loan unless you have an open bank account for a certain period or are a current customer or invited only.
Decide How Much You Need
It is very important that before applying for a bank loan, you must calculate the amount that you need as a loan for the future, or you should also calculate whether you can pay back the loan on time.
To determine the loan amount, you should follow these steps:
- Make sure you know what your monthly budget is.
- Take a look at your finances.
- Think about existing liabilities.
- Make sure you know how much interest you’ll pay.
- Calculate your EMI with an online calculator.
Check Your Credit Score
To determine how likely you are to repay the loan, lenders, and banks typically run a credit check on you when you apply for a loan. Although some online lenders now look at alternative credit data in addition to your credit score, your credit score is still likely to be the first thing they look at. To qualify for the best personal loans, it is usually necessary to have at least fair credit – usually between 580 and 669. In terms of getting approved, though, you will have the best chances of getting authorized with a competitive interest rate if your credit rating is excellent and excellent above 670.
You should compare loans from different lenders and banks, even if you already have a bank in mind, to ensure that the one you choose is the one that best suits your needs.
Calculating a loan’s cost using the annual percentage rate, which includes interest and fees, is the best method to compare loans. Banks’ loans can range anywhere from 6% to 25%; finding the lowest APR can mean significant savings.
Comparing rates is also an excellent time to determine what repayment terms and monthly payments are most affordable for you. In other words, the longer your repayment term, the bigger your monthly payments will be. However, you’ll also pay a higher interest rate.
Fill Out the Application
After checking your eligibility, comparing rates, and selecting the best option, you need to apply. Some banks may require you to apply at a local branch, especially if you’re using for a higher loan amount or if you’re applying at a community bank. Most applications, however, can be completed online.
While the application itself will differ from bank to bank, you will likely submit the following documents and information for verification:
- Details about the individual, including name, address, phone number, and date of birth.
- Details of the loan, including the amount, the purpose, and the repayment period.
- Social Security number (SSN).
- Proof of income and employment.
- Current debt information.
- Costs associated with housing, including monthly expenses.
Once you submit the application, your credit score will be temporarily lowered by a few points due to a hard credit check. Depending on the bank, the decision may be made within minutes, or it may take some time.
Complete the Loan Agreement
You will receive the loan agreement once you have been approved for the loan. You may be required to sign the agreement in your local branch by some banks, while others will allow you to sign the contract electronically. The amount of the loan, repayment term, APR, and monthly bank loan payment amount should be verified by carefully reading the loan agreement.
You will receive the funds once you’ve signed the loan agreement, which usually occurs within a week after you’ve been approved. Still, some banks promise next-day funding after your application has been approved. Funds can be directly deposited into your personal checking account, or a check can be mailed to you.
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Loan Terms to Watch For
During the review of a loan’s terms, several pieces of information should be considered. Going through a loan contract, especially if it is a more complicated loan, like a mortgage, can take quite some time. Certain terms should always be kept in mind when taking out a loan if you cannot read a loan agreement in its entirety.
- Loan Repayment Period
The first loan term you should familiarize yourself with is the repayment period for the loan. The repayment period refers to the length of time you have to repay the loan.
- Interest Rate and Fees
Ensure you pay close attention to any fees that may apply, such as late fees. There is also the possibility that you will be charged a prepayment penalty by some banks even if you pay off your loan early.
- Other Loan Terms and Conditions
It’s important to keep in mind some other loan terms, aside from the repayment period and costs. If any wording related to default appears in the loan terms and conditions, you should review them.
Loan Interest Rates
Next, the interest rate and fees are the most important loan terms to consider after the loan repayment period. An interest rate is the interest rate you’ll pay on your loan; fees are any charges you’ll need to pay to receive the loan. Your annual percentage rate (APR) shows the total amount you will have to pay back over a year based on the amount you owe each month.
As a loan agreement specifies the interest rate on your loan, the interest clause is essential since it tells you how much you will be charged. In terms of interest, there are primarily two types:
- Fixed fee rates
- Floating fee rates.
Fixed fees are set at a specific number, which will not change throughout the loan process (e.g., an 8% fixed rate). A floating fee rate combines an interest rate margin plus a benchmark rate (i.e., 3% plus the benchmark rate).
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What Will Your Loan Payment Be
Depending on the type of loan, different requirements need to be met. The calculations for student loans will not be the same as for auto loans or personal loans. The following is a guide to help you use a loan calculator based on the type of loan that you have.
Personal Loan Calculator
You can calculate your monthly payment amount by entering your principal balance, interest rate, and term length into a personal loan repayment calculator. If you’re interested in making additional principal payments and how the length of your loan and the amount of interest you pay will be affected, you can use the loan payment calculator if you have specific calculations.
Student Loan Calculator
Calculate your student loan repayments with a student loan calculator if you’re having trouble figuring out the details. Using this calculator, you can calculate how much you will need to pay each month to pay off your student loans early once you enter your loan amount and interest rate. This calculator will also show you the impact of extra one-time payments or additional monthly or yearly payments.
Home Equity Loan Calculator
The first thing you will need to do for an equity loan is to use a home equity loan calculator to determine how much you can borrow.
In this form, you will need to provide your address, your estimated home value, your estimated mortgage balance, and the credit score you have. You will be able to borrow more through a home equity loan if you have equity in your home. Still, your credit score plays a significant role in how much you can borrow and your pay interest rate.
Auto Loan Calculator
Make sure you do your homework first with an auto loan calculator before applying for a car loan at the dealership. You will be asked to enter the loan amount, loan term, and interest rate, as well as whether you want a new or used car. You can compare how different terms might affect your monthly payment when taking out auto loans versus personal loans or home equity loans.
Deciding Which Loan is Best for You
Your financial needs and circumstances will determine which loan is right for you, and you should not rely on someone else’s recommendation. It will depend on the purpose of your loan, that is, you will have to decide what type of loan you are going to borrow from a bank.