An in depth beginners guide on borrowing money

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As a first time borrower, the entire exercise may seem somewhat intimidating and complicated. While the process is simple to understand, the ramifications are seldom considered seriously. Borrowing money is a legally binding arrangement whereby you are given a set amount of money, which you agree to pay back, with interest. Depending on the type of loan, the term of the loan can last anywhere between 1 year to 30 years. The interest rate will also vary depending on a number of factors, which are explained in more detail below. 

As this is a legally binding agreement, a failure to meet your obligations, which mostly consists of repaying the money on time, would result in a list of adverse outcomes including forfeiture of security, repossession, or even recovery proceedings before a court of law. So whether you make your payments every month on time or default and give the money back under a court order, you’ll be taking a hit to your finances. As such, you need to carefully consider every aspect of the arrangement before signing a loan agreement. 

The above should, in no way, discourage you from borrowing money especially considering that loans have almost become a necessity if one wants to enjoy even a semblance of quality of life. In today’s economy, most people cannot afford to pay for college tuition out of pocket and families are often forced to consider mortgages with house prices being where they are today. There are also emergency situations to consider such as medical treatment and death where one would need to access money fast. 

Rather than completely shun away from the idea and compromise on one’s quality of life, it would be better if a prudent approach were taken throughout the exercise. Considering the liability and responsibility involved in obtaining a loan, prudency will ensure that you have a payment plan that is manageable and fulfills your needs properly without putting you under unnecessary liability. 

This guide will aim to give you some tips on how you can take such a prudent approach to find a loan arrangement that is ideal for your needs. Hopefully, you’ll have an in-depth understanding of how loans work and what factors you need to look out for in your search. 

WHEN YOU SHOULD GET A LOAN

First and foremost, you should ask yourself if you’re borrowing money for the right reasons. If you’re borrowing because you want to renovate your bathroom for your anniversary, then borrowing is a stupid idea. It’s much better if you save up for such a luxury over a short period of time rather than borrow the money and repay it back with interest on top for something that’s worse than a depreciating asset. 

However, bathroom renovations notwithstanding, there are obviously some situations where borrowing money is more of a necessity than it is an option. In today’s market, buying a house out of pocket is an impossibility for a majority of the population. Furthermore, you don’t have complete title over the property for the duration of the mortgage and the lender can repossess the house if you default on your payments. However, you will be able to call it your own home until you can keep making the payments and your family gets to enjoy a quality of life.

It’s also smarter to buy a car by using a financing model rather than paying out of pocket. Cars are a depreciating asset and as such, it would be smarter to purchase on a payment plan for a set time and continue that payment plan onto another car without having to pay the full value of the car at any point. Loans are also a good way for one to start or grow their business due to the grace period usually involved in business loans. Furthermore, you would be getting a cash injection without having to dilute share ownership and if your business grows fast enough, you can even pay off the loan before the grace period is up.

It’s also understandable if one were to get a loan for emergency situations such as unforeseen medical bills, emergency surgery, or unexpected death in the family. Under such circumstances arranging finances from independent sources is not always an option and getting a loan is a somewhat more convenient route especially in such a stressful time. 

Sometimes people also get a loan in order to pay off all existing loans and just have consolidated payment to make every month. Debt consolidation loans, as they’re called, are great if you want to improve your credit score, manage all your loan payments under one umbrella, and boost your financial health.

However, regardless of your reasons for borrowing money, one should remember that a loan is only an option when it is necessary and not to fulfill some luxurious want. If you’re going to be bound to a legally binding agreement for money then at least do it for the right reasons.

PAPERWORK, PAPERWORK, AND MORE PAPERWORK

Loans are a drawn-out arrangement and involve a number of formalities and considerable paperwork. Depending on what type of loan you’re applying for, you could be asked to submit documents such as bank statements, credit reports, employment letters, resumes, character certificates, etc. Considering all of this, it’s no surprise that it can take time until your loan is approved and you’re given the paperwork to sign. Make sure you have all the documentation ready and be prepared to wait for a little while. 

You could get lucky and find lenders who have shorter processing times. You can ask around among family and friends for such companies or can even research yourself online. All you would need to do is type “quick loan companies in NZ” and you’re bound to find a company that can help you out. However, you should know that such loans will not be for a very large amount and you will need to give some basic information at the very least so be prepared all the same.

BUDGETING IS KEY 

When you take out a loan, you’ll be agreeing to pay a monthly installment that will go towards slowly repaying the entire loan amount. This installment is known as an ‘Equated Monthly Installment’, or EMI, and defaulting on it can cause a lot of problems for the borrower. You’ll be able to find out the EMI when you’re talking to your lender about your borrowing options and once you’ve spoken to a few lenders, list all the different EMIs and check them against your budget to assess if you’ll be able to make the payments.

This EMI also needs to be checked against your savings for emergency purposes. For example, if you were to be laid off your job tomorrow, then you should have enough money in your savings to pay three or four installments. Creating this cushion in your savings would be ideal before you apply for the loan, as if you were to do it afterward it would be a bit more difficult as you’ll already be making the payments which will put further strain on your budget.

This is a very important factor to consider as it will be a constant in your life for a considerable amount of time. If you have a 5-year loan, then you’ll still have to make the payment even if you get married, have kids, and need to buy a house for your new family. Therefore, you’ll need a considerable amount of foresight as well, especially if you’re considering a long term loan.

CREDIT SCORE

Credit scores are vital to the entire lending process. These scores are an indicator of financial credit history and represent a number of factors including the amount of money borrowed and repaid, number of outstanding loans, adherence to the repayment schedule, etc. Lenders take all of these factors into account when assessing a loan application and credit scores are a great way to pre-screen applicants.

The worse your credit score is, the higher the interest rate you’ll be charged until your score is so bad that no lender is willing to give you any money. Also, your credit score will have a bearing on the amount of money that lenders are willing to give you and the repayment schedule that you’ll need to follow. Therefore, it is vital that you maintain your credit score at a good rating. Checking your credit score is also relatively easy nowadays with the access that the internet offers to consumers.

If you have a bad credit score, you can consider a number of options to help refresh or improve it, such as debt consolidation loans. You could also speak to a financial consultant who can suggest different investments and accounts you can consider to help improve your credit score. Nowadays there are even apps that will notify you of different ways to maintain your credit score and allow you to have ready access to your credit information whenever needed.

INTEREST RATES

Interest rates are what lenders charge on loans in order for them to make a profit of the fact that they are lending you money. The higher your interest rate is, the more money you’ll be paying back, on top of the amount that was loaned to you. That is the cost of the facility of obtaining a loan and, as such, you need to be very clear on the interest rates and how they are structured throughout your entire loan arrangement.

Long term loans tend to have a higher interest rate than short term loans do as the prolonged-term of the loan is an added risk for the lender. Credit scores also have a great impact on interest rates as the factors behind assessing credit scores, as explained above, are all risk factors for lenders.

RESEARCH, RESEARCH, AND MORE RESEARCH

When it comes to loans, it is vital that you carry out market research. The competition in the commercial lending sector is unbelievable and you’re bound to find a deal that will perfectly match your requirements. When meeting with lenders, be sure to cover all bases discussed above. Discuss repayment terms, payment schedule, interest rates, default events, and consequences, etc. Leave no stone unturned without worrying about irritating the lender as it is their job to ensure you are clear with all this information. 

You should start your research with your very own bank as the preexisting relationship is beneficial to both parties. The bank will also consider this relationship when they’re assessing your application and there’s a good chance you’ll find the deal you want with them. Also, check your local laws regarding commercial lending so you are aware of your rights.

Speaking to a broker could also be beneficial because they are able to find different loan options from a long range of lenders in a relatively shorter amount of time. Also, because of their status as a broker in the market, they’re going to have special commercial arrangements in place with different lenders, allowing them to offer you unique deals. 

WHAT DO LENDERS LOOK AT?

Lenders look at all the factors we’ve discussed above, and then some. Age is one such factor and applicants falling in the range of 28 to 55 years are most favored. People falling in this range are seen as more likely to be able to pay back a loan. Simply put, a 32-year old with a government job is more likely to pay back a loan than a retired 65-year old with a pension.

Then there’s the applicant’s job. This is a factor that lenders consider especially when it comes to long term loans. Lenders gauge different applicants on the basis of their occupation or profession to judge their potential to repay the loan. While this isn’t a factor on which lenders will outright reject an application, it will have an impact on interest rates, loan amounts, and repayment terms.

In an extension of the occupation of the applicant, lenders will also look at the employment history. People who switch their jobs too much are seen as flaky and unreliable and will be looked at as a higher risk in comparison to someone who has spent increments of a few years with different companies. Structured career growth comes off as a sign of reliability to lenders and is seen favorably as such.