September 9, 2020
By Rahul Iyer
Choosing the right loan is important not only to your immediate cash needs, but your overall finances. Choose the wrong loan and you could struggle financially or pay more than necessary for the funds.
How do you choose the right loan? Consider the following factors.
Most people know to look at the interest rate, but do you know why? It affects your monthly payment, which most people know, but what about the total cost of interest?
If you look at the ‘big picture’ you’ll see how much a loan costs over its lifetime. This is when the loan’s term factors in. If you choose a longer term, you’ll likely get a higher interest rate and pay more for interest overall.
The loan term affects many things, but especially your interest rate and payments. The shorter the term the more you must pay back each month, but the less interest you pay. Find the loan with the ‘perfect’ term that’s a happy medium between affordability and low-interest rates.
Many of us jump at the lowest payment, not taking into consideration how long it takes to pay the loan back or its costs over the lifetime. Don’t jump at the first loan offered, but look at shorter terms too and determine their affordability.
This is a big factor. For example, you may want/need a personal loan, but if you don’t meet the lender’s requirements, you can’t have it.
Look closely at the requirements – do you need a specific credit score, debt-to-income ratio, or amount of income? Mortgage loans, including home equity loans, for example, may have flexible requirements because you put your home up as collateral.
Personal loans, on the other hand, are often unsecured, which means there’s no collateral. If you default, the lender loses the money loaned. Since banks often have such tough qualification requirements, many people turn to peer-to-peer lenders. Individuals invest in people like you, providing funds for a personal loan, but often with higher interest rates, giving investors a reason to invest in you rather than the market.
All loans have fees – it’s how banks stay in business. The only exception might be a peer-to-peer loan. Some platforms charge an origination fee (percentage of the loan amount) and others don’t, but instead charge higher interest rates.
Compare the total cost of the loan versus the total cost of interest (over the loan’s term). This gives you the loan’s cost over its lifetime and helps you make a more informed decision.
Take all of the above factors into consideration when choosing the loan that’s right for you. Unsecured loans aren’t always ‘bad’ or ‘more expensive,’ but sometimes a HELOC or cash-out refinance suits you more.
Know why you need the funds, how you’ll use them, and most importantly the loan’s total cost to choose the right loan for you.