Loans are a valuable financial tool that helps consumers afford costly purchases and unexpected emergencies. In fact, more than 20 million Americans currently have personal loans.1
If you need quick cash, know that there are loan options for almost every financial situation. For example, you could apply for bad credit loans if you have a low credit score.
If you have never taken out a loan, you may wonder what you need to apply for one. Keep reading to learn about the different types of loans available and how to start the approval process.
What Are the 3 Types of Loans Available?
When looking for a loan, it’s critical to know about the different options available. Loans fall into three categories based on how they are repaid. The best loan depends on how you prefer to make payments and how long you want to pay off your borrowed money.
- Single-Payment Loans — A single-payment loan is a kind of loan that borrowers repay in one lump sum. Many borrowers use payday loans or cash advance loans.
- Installment Loans — An installment loan is paid off in monthly payments. The repayment length depends on the financial institution you work with and the type of loan you get. However, repayment lengths can range from a few months to a couple of years.
- Revolving Credit Loans — A revolving credit loan allows borrowers to borrow money, pay it back, and then borrow again. Borrowers receive a credit limit based on their credit history and income and can spend up to that amount. Credit cards are a standard revolving credit loan option.
Secured Loan vs. Unsecured Loan: What Is the Difference?
Now that you know the three loan options available, you need to decide whether to get a secured or unsecured loan.
An unsecured loan does not require any form of collateral to secure the loan. Unsecured loans are the most common type of loan that borrowers get. On the other hand, secured loans do require some kind of collateral. The type of collateral you need depends on the lender and the type of loan you get. For example, you may have to provide a car title, high-end collectible, or savings account to get a secured personal loan.
Secured loans can be safer for the lender, as there is a guarantee of repayment. Using collateral can make the approval process easier for individuals with low or unestablished credit scores. But while low-credit borrowers may get approval for secured personal loans, the financial risk is higher. Borrowers risk losing their personal property if they can’t make monthly payments due to unexpected financial issues.
Even if your personal finances are in good standing, financial experts usually advise consumers against using collateral for loans that don’t include auto loans or mortgages. There are plenty of unsecured loan options available. You may find a decent loan offer despite having a bad credit score by researching multiple lenders.
What Are the Five C’s of Credit?
When a financial institution receives a loan application, it will make a qualifying decision based on the five Cs of credit. The 5 C’s help lenders get a better understanding of someone’s creditworthiness. Suppose you want to take out a loan. In that case, it’s essential to know what factors will affect your eligibility to borrow money.
Below is more information on the five C’s of credit.
1. Character
Your character, or personality, was once used to determine if you would make a good borrower. Before the creation of credit scores, it was necessary to dress nicely and present yourself formally before a lender. However, these days, your character is represented by your credit score. Credit scores are a good indication of a person’s trustworthiness and credibility.
The FICO score is the most used credit scoring model by lenders. When you submit a loan application, most financial institutions will pull your FICO score to make a qualifying decision. If you don’t know your current credit score, you can find out for free. Many credit card companies offer free credit scores to borrowers. Or you can use a free credit monitoring site like Credit Karma.
FICO scores are made up of five factors:
- Payment History (35%) – The financial category that affects your credit score the most is payment history. If you pay your bills late, your credit score could drop significantly. Payments that are more than 30 days late will stay on credit reports for seven years.
- Total Debt (30%) – The amount of debt a person has can hurt or help credit scores. According to financial experts, your credit card debt should not exceed 30% of your available credit. If your credit limit is $5,000, you should avoid carrying a balance over $1,500.
- Length of Credit History (15%) – The older your financial accounts are, the better your score credit looks to creditors. Leaving accounts open can help you get a perfect credit score, even if you don’t use them.
- New Credit Inquiries (10%) – If you want to take out a loan, keep in mind that your credit score may get lower due to a hard credit check. Whenever a person submits a new loan application, their credit score may decrease by a few points, and their credit reports get updated. Too many credit inquiries can reflect negatively on you.
- Credit Mix (10%) – Using different types of credit can boost your credit score. You could get a good credit score if you responsibly maintain a mix of installment and revolving credit loans. Being able to handle multiple financial responsibilities makes you look more appealing to lenders.
Building a high credit score can take time, but it’s easy once you know what affects scores the most. If you want to improve your poor credit score, focus on making all of your monthly payments on time and paying down your outstanding debt.
2. Cash Flow
Cash flow, also known as capacity, is your ability to adhere to the repayment terms of a financial contract. One way to measure cash flow is to analyze a person’s debt-to-income ratio. A DTI demonstrates how much of your income goes toward debt repayment. A low DTI indicates that you earn more than you owe, while a high DTI means that debt controls your income.
Add all your monthly bills to calculate your DTI ratio to get your total monthly debt amount. Then divide the total by your gross monthly income, which is the amount you earn before taxes and other deductions. The result is your debt-to-income ratio as a decimal, which you can convert to a percentage. If your monthly debt payments are $1,800 and your monthly gross income is $6,000, your debt-to-income ratio is 30%.
According to financial experts, your DTI ratio should be lower than 35%. A high DTI signifies to lenders that you are a credit risk because you have too much outstanding debt compared to your household income.
3. Capital
Capital is your level of financial contribution or the amount of money you have. Financial institutions consider your commitment to debt repayment when analyzing your credit history. Suppose you want to buy your first home. The mortgage lender will consider the size of your down payment in relation to the purchase price. If you provide a high down payment, then the lending risk is lower, and you may get a low-interest rate offer.
4. Collateral
Collateral is the personal property you provide to a financial institution to secure the loan and reduce the lending risk. Secured loans require the use of collateral, while unsecured loans do not. Secured loans can help low-credit borrowers get loan approval from a bank or credit union. Although some online lenders also offer secured loans.
These are a few examples of loan collateral:
- Car title
- Property title
- Cash in a savings account
- Investment accounts
- Machinery/equipment
Using collateral to secure a loan is risky, though. In the event of default, the lender will take possession of the asset and sell it to recoup the remaining loan amount. Carefully consider whether you are comfortable with the possibility of losing your personal property, even if you doubt you will experience financial issues during the repayment period.
5. Conditions
Conditions include the borrower’s financial situation and the economic conditions concerning the loan. Lenders evaluate a borrower’s income stability and economic factors for approval. Financial institutions will consider federal interest rates and other conditions because the state of the economy affects them as well as borrowers.
What Documents Do I Need for a Loan Application?
You will need to provide a few documents to a financial institution to get approval for a loan. You will need to bring your documents with you if you decide to apply for a loan in person at a brick and mortar.
Online and traditional loan processes are generally the same. However, online loans tend to be faster and more convenient. In fact, you may not have to provide any documentation for an online loan.
The actual documents you need will vary, but generally, you can expect a lender to require the following items:
- Photo ID: Financial institutions will require a government-issued photo ID such as a state identification card or driver’s license.
- Proof of Income: You must provide income verification to a lender to qualify for a loan. Most borrowers prove they have steady income with bank statements or paycheck stubs. Still, you might be able to use alternative income sources. For example, Social security disability loans allow consumers to use disability checks.
- Proof of Address: To prove you reside at your current address, you can typically provide a credit card statement, utility bill, lease agreement, voter registration card, etc.
- References: Some lenders may ask for a couple of personal or professional references.
- Collateral: You will have to provide documentation for collateral or the tangible object if you apply for a secured loan.
What Are the Most Common Emergency Loans?
Now that you know more about the process of taking out a loan, you may want to know how to pick the best loan for your current financial situation.
The best loan for you depends on the following factors:
- What do you need the loan for?
- How much money do you need?
- How much time do you want for repayment?
- Do you want to use collateral?
Answering these questions can help you narrow down your loan options. Once you have an idea of what loan terms you want, you can choose the type of loan you want. Below is a list of standard loans people take out in the United States to deal with financial emergencies.
Personal Loans
A personal loan is an installment loan that provides a lump sum to borrowers. Most personal loans have fixed interest rates, which means your monthly payment remains the same from start to finish. The repayment length varies but usually lasts a few months up to a couple of years.
Getting approved for a personal loan depends on your credit score and income. Got bad credit? You may still qualify to borrow money with a personal loan lender. The personal loan application process is quick, so you can get a same day online loan for financial emergencies. While rates are generally decent, comparing personal loan rates to find the lowest one is still a good idea.
Payday Loans
A payday loan is a short-term loan that provides small amounts of money. Payday loans tend to have high approval rates because credit is not an essential qualifying factor. All you need to qualify is a steady source of income and proof of identification. However, payday loans are notorious for being difficult to repay because borrowers typically only receive two weeks to pay off the high-interest loan.
Credit Card Cash Advance
If you already have access to a credit card, you can withdraw cash at a nearby ATM! The amount you can get through a cash advance depends on your credit card limit and issuer. Every credit card issuer has a different cash advance limit. This limit is typically less than half of your total credit limit.
Credit card cash advances can cost a lot. You are subject to a high cash advance annual percentage rate (APR) when you withdraw money. The credit card company may also issue a flat cash advance fee. And if you withdraw cash at an ATM, you will likely have to pay an upfront operator fee. Read your credit card’s terms and conditions to learn how much a cash advance will cost.
What CreditNinja Wants You To Know About Taking Out a Loan
In order to take out a loan, you typically need to provide specific information and a lot of documents. However, many online lenders do not require any paperwork!
At CreditNinja, documentation is not usually required, which means our approval process is much faster than traditional bank processes. All you have to do is complete our online application form with basic information. Inquire today to see just how easy it can be to get quick cash loans.
If you need to know more specific personal finance info, like what a share secured loan is, check out the rest of the CreditNinja Dojo blogs!
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