With practically every lender in the country offering loans you have a wide array of options to choose from. It is important to compare loan rates and choose the best deal. Even a 0.25% difference in the interest rate can you save hundreds of dollars over the course of the loan.
A loan can be helpful for you in many ways. You can use the proceeds to meet your short-term financial needs, consolidate your debts, start a small business, buy or fix a home and a variety of other purposes.
Let’s take a look at the key factors you should consider while choosing a loan.
Interest rate
Interest rate refers to the percentage of interest charged by the lender on the principal amount. It is one of the key factors that need to be taken into account while shopping for loans.
Depending on your preference, you can open the door for a fixed-rate loan or a variable loan.
In a fixed-rate loan, the lender charges the same amount of interest throughout the course of the loan, irrespective of the market conditions.
Your monthly installments also remain the same throughout the loan’s term. If you have a good credit score, debt-to-income ratio and credit utilization ratio, you can easily qualify for a low rate of interest with most lenders.
In a variable rate loan the lender tends to increase or decrease the rate of interest depending on the market conditions. Thus your monthly installments also tend to increase or decrease from time to time.
Studies show that you are likely to pay less interest on a variable rate loan compared to a fixed rate loan in a decreasing interest rate environment.
Annual percentage rate
Commonly referred to as APR, annual percentage rate is the total cost of a loan expressed in terms of a percentage on a yearly basis. It includes the interest charged on the principal, origination fees, application fees, and various other fees and charges associated with the loan.
Multiple loans with the exact same interest rate can have different APRs based on the fees charged by the lender. While shopping for loans you should compare the APRs in order to accurately determine how much you have to pay over the course of the loan.
Origination fee
The origination fee is the amount charged by the lender to cover the costs associated with processing your application. It can range anywhere from 1% to 8% of the total loan amount.
Lenders typically tend to deduct the origination fee from your loan amount. For example, if you apply for a $10,000 loan, and if the lender charges a 5% origination fee, you will only receive $9,500.
In some cases, the lender might add the origination fee to your loan balance. In this scenario, you will receive the entire loan amount of $10,000, but you will have a principal of $10,500.
It is generally not a good idea to have the origination fee added to the principal as you will be paying interest on a larger amount. If it gets deducted from your loan amount right at the beginning, the amount you receive will be slightly smaller, but you can save a lot of money on the interest paid over the course of the loan by doing so.
Collateral
The vast majority of lenders offer unsecured loans, meaning they do not require any collateral. The lender usually assesses your creditworthiness by doing a background check and a credit check.
You can also find lenders who offer secured loans which require collateral. Secured loans generally have a lower rate of interest compared to unsecured loans. However, if you default on your loan you risk losing the property you pledged as collateral.
Monthly payment and loan term
How much will you be paying on a monthly basis? Does the amount comfortably fit into your budget? This is something you need to know before zeroing in on a loan offer.
Your monthly payment depends to a great extent on the loan term, which can be anywhere from 12 months to 84 months. Generally, the longer the term, the lower your monthly payments are likely to be.
It is actually one of the reasons why many people opt for loans with longer terms. Doing so, however, is likely to cost you more over the course of the loan.
Let’s consider a $10,000 loan with a 6% APR. If you choose to repay the loan over a three-year period, you will pay approximately $300 a month. By the end of the term, you would have paid $950 in interest. If you choose to repay the same loan over a five-year period, you will only pay $193 a month.
However, by the end of the term, you would have paid $1,600 in interest. In other words, an extension of two years results in a $600 increase in interest payments.
Prepayment penalty
You also need to check with the lender if there is any penalty for paying off the loan early. Most lenders impose a prepayment penalty on borrowers who pay off their loans early, in order to make up for interest you would have paid if you had repaid the loan based on the original amortization schedule.
Some lenders tend to charge prepayment fees even for partial payments, that is, any amount of money you pay in addition to your monthly installment.
Before choosing a loan offer from a lender ask if they charge a prepayment penalty, how much do they charge, and under what circumstances the penalty is applicable.
The bottom line
The aforementioned factors can help you determine if a loan offer from a lender is worth considering or not. Never, ever accept the first offer you receive from a lender. Ask for quotes from different lenders, compare the terms and conditions, and choose an offer that suits your needs.
You also can negotiate with lenders for a lower rate of interest and other favorable terms and conditions, especially if you have a solid credit score.
