Borrowing For Beginners - A Beginners Guide on Loans

12:13 12 November 2019

Borrowing money is a serious matter and one should not underestimate the ramifications of defaulting on a loan, regardless of whether it is a personal loan of $2000 or a mortgage for $2 million. In getting a loan, you are entering into a legally binding arrangement whereby the money that has been extended to you will be paid back, along with interest (explained more below), in equal monthly installments (also explained below) for a set period of time. 

If you were to default on any of your monthly payments, you would be liable to a range of actions including forfeiture of security, penalties, fines, and, most worrisome, recovery proceedings before a court of law. It could also be possible, depending on your loan, that you would face all of these adverse actions if you were to default on your loan. However, these adverse events are not the only reason to be somewhat wary of borrowing, as these only cover the legal and financial implications if you were to default on your payments.

There are also the financial implications of the loan itself that you must also consider. Because loans are legal arrangements, your obligations will stand regardless of your financial or personal circumstances. You could get married and have a child, but the loan payments will still stand. 

However, one can deal with all of the above issues by having contingencies in place and by taking a calculated and informed approach to the entire borrowing process, all the way from speaking to different lenders to signing the dotted line. After all, one cannot simply shun aside the entire concept of loans, especially considering that it has become almost necessary in today’s economic climate. Most people require a student loan to pay their way through university, and paying for a new house out of pocket for your growing family is not something the majority of the population can afford to do.

Today, we’ll be discussing the contingencies you can have in place to help you ensure your monthly installments are paid on time. We will also be giving you tips so you can take an informed and calculated approach to the entire process. Overall, you will learn the necessary elements of a loan, the factors that you should take into account when applying for a loan, and the perspective of lenders when they are considering a loan application. 

BE A BOY SCOUT – ALWAYS PREPARED

Considering the complicated nature of loans as briefly explained above, it’s no surprise that a considerable amount of red tape is in place. There are a number of formalities in place which are not only extensive in number but also quite demanding. At the minimum, you will need your bank statements, bank account maintenance certificate, credit report, employment letters, salary slips, character certificates, and maybe even a legal guarantee. If you forget any of these documents at the time of submitting your application it’ll delay the process even further.

When you’re speaking to lenders, take a notebook with you and have them write down the list of required documents or write them down yourself. Make sure the list is complete and double-check with the lender if you have to. Alternatively, to help along the process you can try searching the lender’s website to see what documents are usually required and take what you have with you. That way you can have a more conclusive discussion as well. 

You should know that with so much red tape, it’s only natural that loan approvals take a considerable amount of time. Depending on the type of loan, you could have an answer in one day or even after an entire month. It goes without saying that patience is a virtue and especially so when it comes to loan approvals. You could try looking for a lender that offers fast loan approvals. All you would need to do is search something along the lines of “same day loans NZ” and you’re bound to get a list of lenders in your local area. 

BUDGETING IS KEY 

As explained above, loans involve a monthly repayment, which slowly adds towards repaying your loan over the long term. This monthly repayment, known as Equated Monthly Installment, also includes the interest accrued on the loan amount. Again, depending on the type of loan, you could be paying it off for a very long time, One example is a mortgage where you get the loan when buying the house and as your family grows, as your kids start going to school and then to university, your expenses will continue to rise, but your mortgage payment will still stand. You need to figure out a way to pay the installment regardless of what your expenses may be, otherwise, you risk losing the house.

Considering the massive financial impact of loans, it would be wise if one were to first sit down and work out their budget to figure out if they’ll be able to make the payments with their current earnings. Furthermore, it would also be wise if you were to adjust your savings in light of the loan. Create a small cushion in your savings to be able to make at least 4 monthly payments, as you might need it for any unforeseen and unfortunate circumstances. You could get laid off your job and would need such a cushion in your savings to help make the payments until you find a new job. 

It also helps if you employ some foresight. As given in the example of mortgages above, some loans can last a significant amount of time and, as such, you need to figure out if you’ll be able to continue making the payments even if circumstances were to change. For example, if you were to have a new baby, then how would it impact your budget and would you still be able to make the monthly payments? Questions along those lines will help a great deal. If you’re having trouble with this aspect, try speaking to an accountant or financial consultant who can help you with budget analysis and projection. 

Therefore, before you apply for a loan, sit down and sort out your finances to make sure you’ll be able to meet your commitments and pay your monthly installment on time.

CREDIT SCORE

Simply put, your credit score shows how creditworthy you are. The higher your score is, the more lenders will be willing to lend you money, the lower your interest rate will be, and you’ll qualify for a larger amount of money over a more relaxed period of time. There isn’t a formula set in stone that helps one calculate their credit score, but the factors behind the calculation are always the same regardless of which authority calculates your credit score. Some of these factors include the number of outstanding loans, the amount of money borrowed and repaid, and adherence to the installment plan by making timely payments. 

Checking your credit score is quite easy and maintaining a good credit rating doesn’t involve a lot of rocket science. You need to stay punctual when it comes to your payments and this punctuality translates to reliability in the eyes of the lender and it is one of the most important factors that lenders look for when considering loan applications.

It also helps if you’re mindful of the number of loans you have. The more loans you have, the more it is a sign of financial irresponsibility, which the lender will never look on favorably as it puts the lender in too much risk. Furthermore, if you’re already drowning in debt, lenders will be less willing to lend you more money. It could help if you were to get a debt consolidation loan in such circumstances. Using this instrument, you can pay off all your existing loans and then have to deal with one single payment which is not only easier to manage but will reflect better on your credit report.

INTEREST

Interest is the profit that lenders make on lending you money. In terms of consumerism, the product is the loan, and the cost of the product is the loan amount and the interest applicable to it. For the manufacturer, a.k.a. the lender, the loan amount is the cost of “manufacturing the product” and the interest is the profit made off that product. This interest is the only incentive for the lender, which might be contrary to all those heartwarming commercials you see for lenders and banks. 

Long term loans, such as business loans and mortgages, have high-interest rates in comparison to short terms loans, and this interest rate can also vary after a predetermined partial period of time of the loan has expired. The reason for the higher interest is because since the term of the loan is such a long period of time, the risk taken on by the lender is much higher and therefore the profits on such a risk would also be higher, albeit more predetermined than one would think when considering “risks”. However, the good news is that because the interest is spread out over such a long period of time and in so many installments, the impact is felt less. 

In addition to the interest, some lenders will also include hidden costs and will call them “official fees” or “miscellaneous expenses”. When you’re speaking to your lender, make sure you get a quotation for your equated monthly installment and ask your lender to break it down for you in detail. Ask what different elements make up the monthly installment amount and try to have that breakdown included in your official loan contract. It will also help if you can get the lender to include a term in the contract where it expressly mentions that the repayment will solely include the borrowed amount and the applicable interest, provided that is the arrangement your lender is advertising and offers.

DO YOUR RESEARCH

It is also vital that you thoroughly research the market to see all your options. Going to one lender will only limit your options and chances are you’ll be compromising on your needs and legally binding yourself unnecessarily to an arrangement that does you no good. As mentioned above, the economic climate is very different today, and consumers are not the only ones suffering from it. Commercial lenders keep popping up and the amount of competition in the market will ensure that you find a deal that is perfect for you.

Therefore, talk to a few lenders and truly explore your options before you bind yourself to a payment plan. Ask family and friends for personal recommendations if you’re ok with it. However, considering personal finances are a sensitive topic to discuss, it’s better if you were to handle this task on your own. You can look in a local directory or even carry out an internet search for some different lenders. 

To make things easier, start with your own bank to see what loans they can offer you. As a bank, commercial lending will be one of their core businesses. Furthermore, you’ve already got an account with the bank and they’re aware of your financial history as it is. The preexisting relationship could also work in your favor and the bank could even offer you some unconventional deal that will be easier to pay off in the long run. If nothing else, it might help you during negotiations with the bank on loan amounts, terms, and interest rates.

If the bank doesn’t work out, you can then consider independent commercial lenders. When you speak to the bank or the lender, be sure to ask each and every question that pops into your mind. Whether it’s about variable interests, or monthly payments, or credit scores, just ask and address every query you have. It is your right, as a consumer, to ask questions and the lender’s job to answer all these questions to ensure you’re fully aware of the financial arrangement you’re entering into.