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How to take out a loan

how to take out a loan

In general, the steps to take out a loan involve applying, verifying information, and finding out about final approval. 

Loans can provide fast financial relief when you are facing upcoming bills or unexpected expenses and don’t have enough in your savings account. If you are considering applying for your first loan, you may wonder how to take out a loan, or what you need for a personal loan. Keep reading to learn about your financial options and how to submit a loan application.  

Common Loan Options for Emergency Cash

If you need to borrow money through a financial institution, you must first decide on the type of loan you want. Various financing options are available, and they all provide different repayment terms. The best loan for you depends on your financial need, repayment preferences, and financial situation.

Keep in mind that most lenders and credit card issuers will perform a credit check. There are two types of credit checks: hard and soft. Each type of inquiry affects you differently, but both are necessary for borrowing money. 

  • Soft Credit Inquiry – Used to get a preapproval loan estimate or decision. Soft inquiries do not affect your credit score. However, a soft credit check may appear on your credit report. At the end of two years, it will fall off your credit report.  
  • Hard Credit Inquiry – Done when a consumer submits a loan application for emergency funding. It can decrease a credit score by five points. Hard inquiries appear on a credit report and remain for up to two years. 

Here are some common loan options for consumers: 

Payday Loans: How to Take Out a Payday Loan

Payday loans are convenient for people that need money in between pay periods. You can get a short-term loan that provides a few hundred dollars quickly. If you are curious about how to take out a payday loan, you’ll be happy to know the process is simple. Payday loans generally have high approval rates because a consumer’s credit score is not one of the main qualifying factors. You may qualify for payday loans even without excellent credit. 

The main difference between payday loans and installment loans is the repayment length. 

Payday loans have a two-week repayment length, so you don’t have to worry about committing to a monthly payment amount. Suppose a borrower fails to pay back the loan amount within that time frame. In that case, the loan will renew, and the lender will add a “rollover fee” to the total loan amount. 

Many payday loan borrowers end up stuck in a cycle of debt due to extremely high-interest rates and short repayment terms. In fact, 91% of all payday loans are made to borrowers caught in a cycle of repeat borrowing with five or more payday loans per year.1 Many financial experts refer to payday loans as predatory due to unfair, deceitful loan terms and advise people to consider other loan options.        

Information on Auto Title Loans

You can use the pink slip to get emergency cash if you lack a good credit score but have a car in your name. Auto title loans are a secured loan option that provides a small percentage of the vehicle’s overall market value. During the repayment process, the lender holds onto the certificate of title. Once you pay back the auto title loan, the lender will remove the lien and release the document to you. 

While auto title loans can provide thousands of dollars fairly quickly, they come with high-interest rates and financial risk. If you fall behind on monthly payments, you risk getting your car repossessed and sold at auction. Secured loans are easier to obtain for borrowers with bad credit scores, but they are risky. Consider if you are willing to risk losing access to reliable transportation before applying. 

Personal Loans: How They Work

Personal loan options are an installment loan option that allows you to repay the borrowed amount through monthly payments. You can apply online or visit a bank or credit union in person to get a personal loan. Personal loans can provide thousands of dollars to eligible applicants in as little as one business day. Depending on the personal loan lender, the repayment terms can last a few months or several years.

Most personal loans are unsecured loans, which means you do not need to provide collateral. Since you don’t need to secure a personal loan, qualification for a personal loan largely depends on your credit score and income. However, you may still get a personal loan with decent loan terms if you have a tier 4 credit score. Many personal loan lenders have flexible requirements to accommodate people with bad credit histories but reliable income.   

Line of Credit

A line of credit (LOC) is a loan with a set borrowing limit that replenishes every time the borrower makes a payment. Credit card companies, banks, and credit unions offer lines of credit, although the loan terms depend on the financial institution. Applicants typically need a good or excellent credit score to qualify for a line of credit such as credit card debt. If you have a bad credit score, you may find it challenging to get loan approval. 

While a line of credit is convenient, it has drawbacks. Suppose you want to stop overspending and start saving. In that case, revolving credit like credit card debt, may not be the best financing option. Since a line of credit does not have a set repayment date, it’s difficult to budget, and you may accidentally end up in a cycle of debt. 

Four Factors Financial Institutions Consider for Loan Approval

Most financial institutions base qualification on four factors. If you want to take out a loan, knowing what information lenders scrutinize is crucial. Keep in mind that most of this information will impact the interest rate you get on a personal loan or other loan option. Being informed helps you better understand your financial standing. Below are the four factors you should know that can impact your interest rate and loan approval. 

Credit Score 

Your credit score is one of the most important qualifying factors for unsecured loans. Since you don’t need to use collateral, the lender needs proof that you are a reliable borrower. Your credit history represents your ability to pay bills on time. You may get subpar loan offers with high rates if you have bad credit. But there are loan options for people with less than perfect credit history. For example, you may confidently submit a personal loan application because many lenders offer flexible requirements and a decent interest rate.  

Monthly or Annual Income

When you apply for loans, the lender will consider your monthly or annual income. Having access to a reliable source of income proves that you have the means to pay back the loan. Suppose you have bad credit, but you are also a high-income earner. In that case, it’s still possible for you to get a high loan amount to afford necessary car repairs.  

Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes towards monthly debt obligations. There is no set debt-to-income ratio that lenders require. However, you may not get a substantial loan if you already have a lot of debt. However, financial experts advise consumers not to have a DTI ratio higher than 35% because it can be challenging to manage your finances. 

Collateral   

The type of collateral you use is essential when you apply for secured loans. When you apply for auto loans or home loans, the intended purpose of the loan is also the collateral. But suppose you want a secured personal loan. In that case, you can typically use a savings account, bonds, vehicles, stocks, antiques, etc. But keep in mind that using collateral means you run the risk of losing your personal property. Even if your financial standing is good, it’s always possible to experience unexpected issues.   

What Documents Do I Need To Complete a Loan Application?

If you want to take out a loan, you will need to provide the lender with specific paperwork. Knowing what documentation you need to have ready ahead of time will speed up the process. Generally, most financial institutions will ask for the following documents: 

Loan Application

You must fill out a loan application if you want emergency funding. Online lenders will provide a simple online questionnaire, while brick-and-mortar financial institutions may require a paper application. 

The preliminary application usually requires your name, email address, mobile number, address, and monthly or annual income. Lenders use this basic information to make a pre approval decision. Depending on the lender, you may get an estimate of how much you can get.    

Proof of Identification 

To qualify for a loan, you need to be at least eighteen years of age. Your identification can be proven through a government-issued photo ID, such as a driver’s license, state identification card, or U.S. passport. You will also have to provide a Social Security number (SSN). However, some lenders also accept the Individual Taxpayer Identification Number (ITIN).

Proof of Residence

You must provide proof of residence to get a loan in your state. Official documentation must include your legal name and address. Most lenders accept the following documents:

Document TypeDescription
Recent Utility BillsBills for electricity, water, gas, etc.
Monthly Credit Card StatementStatement for your credit card, you can request that information.
Lease AgreementRental agreement for a lease if you are renting.
Mortgage StatementStatement for a mortgage if you are a homeowner.
Cell Phone BillMonthly bill for your phone, it should have your address on it. 
Voter Registration CardThe card that allows you to vote. 

Income Verification

As proof of access to reliable income, most consumers provide paycheck stubs or bank statements to the lender. But if you don’t earn reliable income or work a traditional job, know that most lenders accept alternative income. You may still qualify by providing government award letters, invoices, recent tax returns, etc.  

References

Some financial institutions will ask for a couple of references to determine if you’re a good loan investment.

FAQS How To Take Out a Loan

What is the difference between fixed and variable interest rates on personal loans?

Fixed interest rates, often found in personal loan offers from banks and credit unions, remain constant throughout the duration of the loan. This ensures that your monthly payment amount remains predictable. Variable interest rates, more common with online lenders, can fluctuate based on market conditions influenced by various financial institutions. These might cause your monthly payments to vary, especially if your credit score is not in the excellent credit range.

How can I improve my chances of getting approved for a personal loan?

Improving your credit score is paramount for personal loans. Ensure that there are no errors on your credit report, maintained by major credit bureaus. Reducing your debt, showcasing a stable source of income through pay stubs or a bank account, and considering secured loan options that require collateral can enhance your chances. For those with bad credit, many online lenders offer specialized loan options, but it’s essential to compare loan amounts, personal loan rates and terms.

Are there any penalties for paying off a loan early?

Some personal loans, especially from traditional financial institutions or credit unions, come with prepayment penalties if you clear the loan before the agreed-upon term. Always review loan documents carefully and consult with personal loan lenders about any potential fees associated with early repayment.

What happens if I miss a loan repayment?

Missing a loan repayment can lead to late fees, a potential increase in interest rates, and severe damage to your credit score. If you anticipate difficulty with monthly payments, it’s paramount to contact your lender, be it a credit union, online lender, or another financial institution, to discuss possible solutions, including loan terms adjustments.

Your payment history is the largest factor that impacts your credit score from each of the three major credit bureaus. Setting up automatic payments from your bank account can really help you avoid missing payments.

Is it possible to refinance a loan?

Yes, refinancing, also sometimes called debt consolidation, is a way borrowers can assess their loan options and replace their current debt with a new one, typically to get a better interest rate or more flexible loan terms. However, this process may involve a credit check, impact low credit scores, or come with origination fees. Personal loans are popular loan options for refinancing or debt consolidation.

What is the difference between secured and unsecured loan options?

Secured loans require collateral, like a house for a home equity loan or a car for auto loans. If a borrower defaults, the collateral can be claimed by the lender. Unsecured loans, like most personal loans, don’t require collateral but typically have higher interest rates due to the increased risk for lenders.

Do all personal loan applications affect my credit history and credit score?

Only hard credit inquiries with a personal loan, which occur when you submit a personal loan application to most lenders, can slightly lower your credit score. Soft credit inquiries, like checking loan amounts or comparing personal loan options for pre-approval estimates, don’t impact your credit scores. Always ensure you’re clear on the type of inquiry being made when applying for a personal loan or any other loan option.

The Bottom Line With CreditNinja: Taking Out a Loan

If you want to take out a loan, it’s crucial to know what lenders consider for qualification, the type of loan you want, and what documents are required. Ask yourself how much money you need and how much you can afford to pay per month. Pay close attention to the interest and annual percentage rates (APR) before signing on the dotted line. 

Getting stuck with a high-interest rate can make the repayment process a struggle. But as long as you ask questions and take the time to compare your financial options, you can easily find the best loan for you! To learn more about different loan types check out CreditNinja’s blogs.

References: 

  1. Fact v. Fiction: The Truth about Payday Lending Industry Claims | Center for Responsible Lending
  2. 5 Personal Loan Requirements To Know Before Applying | Forbes

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