Obtaining a loan could be incredibly helpful. Loans can be used to purchase a home, buy a car, go to college, or even start a business. Understanding how to get a loan can be a bit complicated.
Each loan has its own approval process and requirements. If you’re curious how to get approved for a loan, and the various loan options available today, you’re in the right place. We’ll cover important details below that can help you financially.
What Is a Loan?
First and foremost, let’s start with some basic information. What is a loan?
In its most simplest form, a loan is when an individual(s) or organization lends money to another individual(s) or organization. The borrower is contractually obligated to pay the loan back within a specified time frame.
Additionally, there is often an interest rate the lender charges the borrower for borrowing money.
How Does a Loan Work?
The mechanics of a loan can differ depending on the loan’s terms and conditions. But on a high level, there is always some consistency across loan products.
The first consistency is the fact that a loan is between two parties, the lender (the individual or organization lending money) and the borrower (the individual(s) or organization borrowing money).
The second consistency is the fact that the loan will be issued with agreed-upon terms and conditions. These terms and conditions will outline; the length of the loan, the interest rate of the loan, the repayment schedule, and the course of action if the borrower defaults on the loan.
Last but not least, a loan will require an application process. Although the application process and the requirements, will differ between loan products and lenders.
For example, if you’re wondering how to get a business loan, that application and approval process may be different from how to get approved for a home loan.
Different Types of Loans
There are a variety of different loan products available on the market today. Here are some of the most common types of loans:
A mortgage – This is a loan product where a borrower borrows money from a lender to purchase a home or residential property. Mortgages come in all shapes and sizes, but the most common mortgage is a fixed-rate 30 year mortgage. That simply means the repayment duration on the mortgage is 30 years, and the interest rate, or the fee the lender is charging the borrower, is a fixed flat rate for the duration of the loan.
A Small Business Loan – If you’re wondering how to get a small business loan, there are a few things you must understand. First and foremost, the money received from a small business loan must only be used on your small business. Secondly, lenders will need to see your business plan as they’ll want to make sure your business will generate enough money to repay the loan. Thirdly, there may be loan covenants that the lender puts in place.
A Personal Loan – This is another type of loan on the market today. A personal loan comes in all shapes and sizes and can be used for a variety of reasons. Many times, people use a personal loan to purchase a car, consolidate debt, or pay for a major expense – such as a kitchen remodel or medical expense.
A Business Loan – This is another type of loan product. A business loan is for established companies that need money to make various investments or upgrades to their business. For example, perhaps an established grocery store wants to expand its operation and open another store location. This expansion will cost $1,000,000. The business can obtain a business loan to pay for this expansion, so long as the business meets the lender’s requirements.
How Do I Qualify for a Loan?
If you know you want a loan, you may be wondering how do I qualify for a loan? The truth is, each loan and lender will have its own qualification requirements. However, there are a lot of common similarities.
A lender will want to make sure the borrower or business is credit worthy. Maintaining a healthy credit score will improve your chances of getting a loan.
A lender will also want to have confidence they will get repaid. As an individual, that means you have an acceptable debt to income ratio. As a business, that means your business is generating enough cash and profit each month to repay the loan.
Additionally, a lender will likely require some sort of collateral. For example, when you get a mortgage, the lender reserves the right to foreclose the home if you do not meet the agreements of the loan.
If you obtain a car loan, a lender reserves the right to repossess the car if you do not repay the loan.
Pros & Cons of Taking Out a Loan
With all loans, there are pros and cons.
Let’s start with the pros. Loans can be used to:
- Purchase a home, which could be a great long term investment
- Start your own business
- Expand and enhance your existing business
- Consolidate debt and reduce your overall blended interest rate
However, there are also cons to loans, such as:
- A loan can put additional financial pressure on your personal life or business
- Loans could be used to buy things you truly don’t need
- Loans could come with a very high interest rate, which is never a good thing
6 Steps for Getting a Loan
If you’re looking to obtain a loan, follow these 6 steps.
Run the Numbers and Check Your Credit
First and foremost, you should run the numbers and check your credit. Before applying for a loan, figure out how much money you’re comfortable paying back each month.
For example, if you need a car and run your numbers, you may feel comfortable paying back $250 a month. The car you want may be $450 a month, which would be above and beyond the $250 you’re comfortable repaying.
Additionally, knowing what your credit score is could be very helpful. If you currently have a poor credit score, you could work on improving that score before applying for a loan.
The higher your credit score is, the more trustworthy you are in the eyes of a lender, and that generally means the lender will lend you money at a lower interest rate.
Consider Different Options and Pick a Loan Type
Pick the loan product that’s aligned with your needs. You’re not going to be able to take out a mortgage to start a small business, nor are you going to get a small business loan to buy a car.
Each need for money can have a corresponding loan product. Find the right loan product for what you’re trying to do, and apply accordingly.
You must visit more than one lender before making your final decision. A large multi-national bank may approve you for a specific loan product at a 3.5% interest rate however your local credit union may approve you for the same loan at a 3% interest rate.
That savings of 0.5% may seem minuscule but it will add up over the lifetime of the loan. Be sure to shop numerous lenders before drilling down on any single lender.
Decide and Apply
Once you’ve decided which lender is offering the best loan package and deal for your needs, apply for the loan through that lender. You may be able to complete the application process online, or you may need to visit the local lending branch to complete the application.
The application process will likely require quite a bit of documentation. Be sure to ask in advance what the documentation is so you can come prepared with the required documents when finalizing the loan.
Documents that can be asked for include, but are not limited to: photo ID, proof of assets, bank statements, credit history, etc.
Make Payments On Time
Once the loan is secured, make sure you adhere to the terms and conditions of the loan. That means, you must pay the loan on time, and in full, each payment interval.
Any missed or partial payment can negatively impact your credit, and it will likely cause you to pay an additional fee.
Be Careful With Borrowed Money
Just because you’re approved for a loan doesn’t mean you should take it. Loans are incredibly useful financial products that help individuals and businesses accomplish their goals.
However, they can also be very dangerous and expensive if used incorrectly. Considering the importance of money management, you should certainly consider working with a financial advisor to help you navigate these complex financial situations.