The basics of Consumer Loans
HOW Consumer LOANS WORK
Need money to pay for something big, like a car? You may need a consumer loan. Let’s look at how these loans work.
With a consumer loan, you receive all the money the lender has approved for you in one lump sum. This is called the principal. Then, to pay the lender back, you need to make equal monthly payments, called installments, for a fixed period of time, until the loan is paid off.
The lender may also charge you fees for giving you the loan. On top of repaying the principal, you’ll also have to pay the lender interest.
How much interest you’ll pay for your loan depends on three main factors: how much you’re borrowing, the interest rate, and how long it will take you to pay the money back, also called the term of the loan.
COMPARE INTEREST RATES of consumer loans
Compare these two sample consumer loans. Note how the interest rate affects the total amount of interest paid.
Interest rate comparison
Loan amount of $10,000 with a 5 year term
As for the interest rate, it’s important to shop around. Some lenders may give you a lower rate than others. In general, the shorter the term, the lower the total interest paid.
By getting a 5% interest rate vs. 15%, this borrower would save over $3,000 interest over five years!
Note: Always try to get a loan with the lowest interest rate you can. Remember: a strong credit score may help you qualify for a lower interest rate.
compare the terms of consumer loans
Check out this example with the same interest rate: with the longer-term loan, the total cost is more than $1,100 higher because you’re paying over a longer time, which means you also pay more in interest.
Loan amount of $10,000 and 10% Annual Percentage Rate (APR)
|About the Loan||Loan A||Loan B|
|Term||25 months||49 months|
|Total cost of loan||$11,106||$12,215|
|Total interest paid||$1,106||$2,215|
Lenders will often offer you options for the term. You might consider a longer term loan to get a lower monthly payment that you can comfortably manage to pay, but always check the total cost of the loan.
cosigning a consumer loan
A cosigner (also known as a co-borrower), is someone who assumes equal liability with the primary borrower for the repayment of a loan. If you’re considering cosigning a loan, consider the following advice from the Federal Trade Commission (FTC):
What would you do if a friend or relative asked you to cosign a loan? Before you answer, make sure you understand what cosigning involves. Federal laws and many state laws pertain to cosigning for a loan. Under federal law, creditors are required to give you a notice that explains your obligations. Some state laws require the creditor to collect from the primary debtor first. An example of a federal cosigner’s notice states:
You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.
The creditor can collect this debt from you without first trying to collect from the borrower.* The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.
This notice is not the contract that makes you liable for the debt.
Studies of certain types of lenders show that for cosigned loans that go into default, as many as three out of four cosigners are asked to repay the loan. When you’re asked to cosign, you’re being asked to take a risk that a professional lender won’t take. If the borrower met the criteria, the lender wouldn’t require a cosigner.
In most states, if you cosign and your friend or relative misses a payment, the lender can immediately collect from you without first pursuing the borrower. In addition, the amount you owe may be increased— by late charges or by attorneys’ fees—if the lender decides to sue to collect. If the lender wins the case, your wages and property may be taken.
Despite the risks, there may be times when you want to cosign. Your child may need a first loan, or a close friend may need help. Before you cosign, consider this information:
- Be sure you can afford to pay the loan. If you’re asked to pay and can’t, you could be sued or your credit rating could be damaged.
- Even if you’re not asked to repay the debt, your liability for the loan may keep you from getting other credit because creditors will consider the cosigned loan as one of your obligations.
- Before you pledge property to secure the loan, such as your car or furniture, make sure you understand the consequences. If the borrower defaults, you could lose these items.
- Ask the lender to calculate the amount of money you might owe. The lender isn’t required to do this, but may if asked. You also may be able to negotiate the specific terms of your obligation. For example, you may want to limit your liability to the principal on the loan, and not include late charges, court costs, or attorneys’ fees. In this case, ask the lender to include a statement in the contract similar to: “The cosigner will be responsible only for the principal balance on this loan at the time of default.”
- Ask the lender to agree, in writing, to notify you if the borrower misses a payment. That will give you time to deal with the problem or make back payments without having to repay the entire amount immediately.
- Make sure you get copies of all important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties—if you’re cosigning for a purchase. You may need these documents if there’s a dispute between the borrower and the seller. The lender is not required to give you these papers; you may have to get copies from the borrower.
- Check your state law for additional cosigner rights.
credit application checklist
potential warning signs
Warning signs to watch for. Knowing these nine predatory lending practices to watch out for can help you to choose a responsible lender.
Encouragement to include false information. If a lender has changed any of your income or expense information or leaves your income blank, do not sign the loan application.
Incomplete loan documents. Never sign a loan document with missing information. Don’t work with a lender who asks you to sign a document that is not completely or accurately filled in.
“Bait and switch” sales tactics, when a lender makes promises in order to make the sale, but then backs out on the promises after the sale. To avoid this, it’s critical to carefully read and understand the agreement before you sign. Question anything in the document that is not consistent with what you were told. Don’t sign the agreement if anything in it is unclear, incomplete, or not as promised.
Equity stripping or skimming, also known as foreclosure rescue. Predatory investors or small companies target low-income home owners facing foreclosure and trick them into signing away their equity and property. For example, they might bury a document in a stack of loan papers that signs over ownership of the home to the loan company, or even forge the homeowners’ signatures.
Loan flipping. Refinancing a loan can be a responsible and useful financial strategy, but loan flipping is when a lender persuades a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time. This is not in your best interest because it costs you money and postpones the loan principal from being reduced.
Some predatory lenders may charge you up to $1,000 for the “privilege” of paying your loan biweekly. Although this can decrease the total interest you pay over the life of the loan and the time it takes to pay in full, such accounts can often be set up for free or for a one-time fee of a few hundred dollars.
Required (or requested) deed signing. If you are behind on your mortgage payments, a predatory lender may offer to help find new financing and ask you to deed your property over to the lender as a temporary measure to prevent foreclosure. But then the promised loan never comes, and the lender who made you the offer owns your home.
Advertisements promising “No Credit? No Problem!” These are often warning signs of scams. Consumers responding to such ads are guided through a phony application process and may even receive fake loan approval documents. To receive the approved loan, they are told to pay money up-front for fees or services — and instead end up losing their money — and in some cases, their homes.
Promises to refinance the loan to a better rate in the future. No one can make you that promise. Instead, ask the lender if there is anything you can do to get a better rate now.
Balloon payments are large, lump-sum payments due at the end of the term. Before you sign a loan agreement that requires one, make sure you fully understand and are prepared to pay it.
you’re at risk
Who’s at higher risk of predatory lending? Anyone can be a victim of predatory lending, but for a variety of reasons some people are at especially high risk:
- People with substantial equity in their homes and low or fixed incomes
- Older adults with substantial equity in their homes
- People with limited knowledge about finance
- People with limited English skills
- People with limited financial access and experience
- Minorities and immigrants
if the lender says no
There are several reasons a loan may not be granted along with 7 steps you can take to have the lender reconsider.
|Reasons a loan may not be granted||Steps you can take to have the lender reconsider|
|1. Irregular employment or limited job history|
2. Not enough income to repay the loan
3. Poor credit history (slow repayment of other loans)
4. Lack of credit history
5. Too short a time at residence
6. Insufficient down payment
7. Insufficient documentation
8. Application mistakes
9. Too much outstanding credit or loan debt
10. Too many (new) accounts or recently closed accounts
|1. No prior credit? Apply for a credit card with a low limit, make small purchases and pay on time.|
2. Find out if all sources of income were considered in evaluating your application.
3. Pay off some of your existing debt.
4. Find a reliable co-signer who is acceptable to the lender.
5. Offer to make a larger down payment if possible.
6. No credit history? Find out if factors such as payment of rent or utility bills could be considered. These factors are called nontraditional forms of credit.
7. Find out if there are errors in the information the credit bureau provided to the lender.
PROS AND CONS OF LOAN CONSOLIDATION
What is loan consolidation? Loan consolidation means combining student loans from one or many lenders into one new loan from a single lender. Loan consolidation won’t reduce your overall debt, but it may make your current monthly payment more manageable. You can even use a consolidation loan for just one student loan.
- Consolidating your student loans can simplify your bill paying. You gain the convenience of making a single monthly payment to a single lender.
- You may lower your current monthly payment by extending the repayment term of your original loans. This can free up cash for other uses.
- You have just one loan to monitor and manage. You have one lender to contact if you have questions.
- With some lenders, you can both manage and repay your loan online.
- Some lenders offer an interest rate reduction when you make automatic payments from a checking or savings account.
- You may pay more over the life of the loan. If you extend the repayment term of your original loan you’ll add to its total cost, since you’ll be paying more in interest.
- Your consolidation loan may offer different benefits than your original loans. You may lose eligibility for certain benefits you qualified for on the original loans if they are consolidated.
After consolidating your loans, you cannot reverse the process. Your original loans are paid in full and you cannot reinstate them.