Loan Essentials

What is a loan?

A loan is a financial agreement where a lender (a bank or financial institution) provides a specific amount of money to a individual or group, also known as the borrower. The borrower agrees to repay the loan amount over time, usually with interest and other fees, according to terms and conditions. It is essential that that both sides of the loan have agreed upon these terms and conditions.

Key Components of a Loan

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Secured vs Unsecured Loans

Secured

(mortgages, auto loans)

A secured loan is a loan that uses collateral, such as an asset pledged by the borrower, to guarantee the repayment. In the event that the borrower is unable to repay the loan, the lender has the authority to seize the collateral in order to recover the outstanding balance. The inclusion of collateral reduces the lender's risk, making secured loans more accessible and enabling them to provide lower interest rates.

Unsecured

(personal loans, credit cards)

An unsecured loan is a loan that does not necessitate any collateral. Instead, these loans are approved by lenders based on the borrower's creditworthiness, income, and financial history. Due to the absence of collateral, unsecured loans carry a greater risk for lenders, leading to more stringent approval criteria and typically higher interest rates.

Importance of Credit Scores

What is a credit score?

A credit score is a numerical representation of a person's creditworthiness, which reflects their likelihood to repay borrowed money based on their past financial history.

Credit scores are utilized by lenders to assess borrower risk and set loan conditions.
- Based on your credit rating, lenders will modify interest rates and, ultimately, the cost of borrowing.
  - Your total amount of debt will be lowered because you will pay less interest the higher your credit score is.

Pay All Bills On Time: If you’re consistently paying your bills on time it shows lenders that you’re reliable and in turn help your credit score. Keep Credit Card Balances Low: It’s best to not use the full limit of your credit card. Instead, try to only use a small portion of it. This ratio can be shown as a percentage. You should always aim to have this number below 30%.
Avoid Opening Too Many New Accounts: Though it might seem tempting to get store credit cards for multiple places just for the discount, don’t. When you apply for new accounts too frequently lenders will start to think you don’t manage your money well and drop your credit score.
Have A Mix Of Credit Types: Having different types of accounts is actually beneficial. This shows lenders how responsible you are with handling money. For example, having an installment loan along with a mortgage can be good.
Regularly Check Your Credit Report For Errors: Every year, there are three major bureaus that provide free annual credit reports. Get one from each of them and review them for inaccuracies. This is important because fixing errors will prevent negative impacts on your credit score.