A loan is a commitment. It might be in your life for many years. It may be just a few years, or it may be several decades. Personal Finance company SoFi reports that the average repayment period for student loans is 20 years. Most car leases range from 24 to 36 months, and reports show that the average monthly payment has crept up to well over $400 in recent years. Meanwhile, if you’ve watched many commercials lately, you’ve seen that a lot of car companies are extending the terms of their lease – offering payment plans that go into the 72-month range. That may seem like it makes the payment more doable but…does it? Or do you just wind up paying much more in the long run?
Lenders are great at making numbers look phenomenal. They also make some of the smallest small print out there. And only once you’ve been enticed by some “perfect deal” are you hit with a massive contract that has you signing what feels like your life away. If you default on a payment, the same people who were so nice to you when you took it on can suddenly become pretty nasty. This article is not written from the standpoint of a mortgage officer, banker, or lender of any kind. This comes from the perspective of a woman who, in the last 15 months, had to refinance student loans and pay off part of a car lease early all to make a mortgage work only to fail to get a refinance on that due to other debt. This comes from a consumer – a borrower – who felt that the professionals didn’t give her the full scope of things. These are questions I wished I’d asked on the several loans I currently have.
Can I improve my credit first?
Your credit score will be one of the biggest driving factors of the interest rate you get on your loan. The interest rate is, quite simply, the amount of money you’re going to spend on your money. This infographic from In Charge Debt Solutions shows just what a big difference your interest rate makes on what you pay over time for your loan. On a $150,000 30-year mortgage, the difference between a rate of 3.2 versus 4.8 (which is what great credit vs poor credit will get you) amounts to just shy of $50,000 more spent over the term of the loan. And let’s not forget that it’s very hard to find a house that cheap, so you can multiply that number a couple of times over for a more realistic view of how your credit score, and your resulting interest rate, affect what you pay. That shows you the importance of asking if there is any way to improve your credit before locking in a rate. We cover some ways to do that here.
Have I shopped around?
Never go with the first rate you see. Never go with the first lender you speak with. In my experience, you will speak to lenders who will tell you that the way they do things is “industry standard.” And that’s only semi-true. When we were getting a mortgage, we spoke to one bank that would only allow a 43 percent debt-to-income ratio. That’s a term we cover in “7 Personal Finance Terms to Know,” but it ultimately meant, whatever I make a month, the bank didn’t want my monthly mortgage payment to exceed 43 percent of that. They told me that most lenders would feel the same way. Then I spoke to just a few more and found that one allowed a 47 percent debt-to-income ratio, and another would go as high as 51 percent. I also simply found lenders offering much better rates than others. I came across some that were very new, so they were offering to cover closing costs and waive application fees in order to build up their customer base. There are so many lenders out there. Shopping around could save you thousands of dollars up front and/or over the term of a loan.
Is the interest rate fixed?
Given the recent dip in mortgage rates, homeowners with variable rate mortgages saw some nice savings this year. That being said, if rates skyrocket, they could take a hit. Finding out if something is fixed or variable is pretty easy and will be one of the first things you discuss with any lender. What they may not put out there quite as big and clearly is if the rate is variable, how high is it allowed to go up? Also, how often are they allowed to increase it? If it’s fixed, make sure you’re happy with the rate because getting out of it could be a headache later.
What do financial analysts say?
If you aren’t sure the rate being offered is great, but you’re struggling to find a significantly better one, talk to a financial advisor. Talk to several financial advisors and analysts. See what they think about the direction rates are headed in. Ironically, when we got our mortgage, we were deciding which day to lock in the rate. Our broker at the time said, “I mean, this rate is about as good as it gets. It would be highly unlikely that rates dropped much more. Unless there was like a pandemic that causes an economic crash or something.” And she really said this. That was November of 2019. Nobody could have seen CO4
VID-19 coming, but some analysts may be able to tell you, for more predictable reasons, that rates might soon increase or decrease. It’s worth consulting them if you’re on the fence about current rates.
What matters more: paying less monthly or overall?
Only you know your financial situation. So you know what will make you feel like a winner in the long run. For some, it’s paying as little as possible every month. For others, it’s paying as little as possible overall for this money. If you want low monthly payments, you’ll want a longer loan term. The interest rate will be slightly higher than on a short loan, but spread out over the years, it will result in more digestible monthly payments. If you want to pay as little as possible overall for this loan, then you’ll likely want a shorter term. You can get a better rate on a shorter term. The lender feels more comfortable charging you less, knowing they’ll get paid back sooner.
What other costs are associated with this loan?
When we were buying our home, all we thought about was scrounging up the down payment cash. So we were surprised when the cash-to-close statement came in and it was about $7,000 more than the down payment. But then there was the appraisal fee. The tile recording fee. The notary fees. The application fee. The office administration fee. The entire year’s home insurance premium paid upfront. Apparently, we had to buy down the rate with points to get the rate we got in order to make the monthly payments work. This is just our experience with a home loan, but you can find the same with a car loan, a student loan, a personal loan, or really any type of loan. Always ask, “What’s the estimated cash-to-close?” That will give you a better look at how much you have to fork over before this loan is a done deal.
How does it fit into my monthly expenses?
This will be a new monthly payment that you’re locked into. Think of everything else in your budget between groceries, rent, car payments, health insurance, entertainment, your pet’s food…the list goes on and on. With this new payment occurring, will you still feel that you’re putting aside money at a comfortable rate? Will you have enough liquidity for an emergency? Do you need to cut back on some luxuries in order to make that happen since having emergency savings that are liquid is very important? Sit down and remake your budget, including this new monthly payment. Make sure you’re okay with what you see.
Are there any penalties?
What happens if you’re late on a payment? Will you be charged a late fee? Does it go up the later you are? What if you have to defer? Will interest compound? Will you lose your loan if you default? How quickly? What if you want to pay your loan off early? Will there be an early termination fee? What happens if your check bounces? Is there a fee for that? If this is a long loan, anything can happen during the term of it. Think about how many people had to default on car payments, mortgages, and student loan payments because of COVID-19. If you have a loan that spans multiple decades, there will likely be bumps along that road. You don’t want terms that will hit you with huge fees.
Can a co-signer help out here?
If your credit score is so low that you can’t increase it to “good standing” quick enough to capitalize on good rates, you do have another option. You could get a co-signer. This could be a family member or a generous friend. A co-signer with good credit and high income makes the lender more comfortable giving you this loan and giving you a better rate. The downside is that, if you default on payments, your co-signer will be held responsible for those. So if getting a co-signer could mean getting a much better rate that saves you thousands over the term of this loan, it’s worth looking into. But for ethical reasons, do not take one on unless you know with near certainty that none of the financial burden of this loan will ever fall on them. My husband and I were on the fence about getting a parent to co-sign so we could qualify for a refinance on our mortgage. We ultimately decided against it because the savings wouldn’t be enough to justify putting that burden on somebody else.
Can I make money with this money?
Don’t take on a loan to buy a depreciating thing that you just really want, like a car that’s out of your price range or a luxury apartment with sky-high rent. Always look at loans as vehicles for more money. A mortgage can be a positive type of loan because homes are typically appreciating assets, so you can make money by borrowing that money. The same can go for a student loan if your field of study pays so much that one day, the monthly payments of that debt will seem like pennies. Some individuals borrow low to sell high in the personal lending game. I am not advising that nor am I qualified to speak to it, but that is – when it works out – a form of buying money to make money. It’s just all too common that people take out personal loans for something that will not make them any money.
Am I using this to get out of debt?
Whenever possible, don’t take on more debt to get out of debt. Before taking out a personal loan to make a late rent or car payment, see if you have family who will help you out. See if your car lender or landlord will cut you some slack. See if you can take on extra shifts at work. See if there is anything you can sell to make some extra cash. Taking on debt to pay off debt is a very dangerous cycle. And, the odds are, if you’re taking on a loan to pay off other debt, your credit score is likely already low, meaning you’ll get a terrible rate on that new loan.
Will it impact future loans?
I took on a new car lease just a few months before applying for mortgages. I never thought about the fact that that monthly car payment would then be on my credit report, and negatively impact my debt-to-income ratio when applying for a mortgage. I needed a car, so there wasn’t any getting around that. However, if I’d known how difficult it would make it to get a decent size mortgage a few months later, I would have leased a – hate to say it – crappier car with a much lower monthly payment. Just remember that lenders want to know what other loans you have. So before taking out one loan, ask yourself if it will impact your ability to get a more important loan later.
Can I really stick to the payment plan?
In many cases, lenders will lend you more than they probably should. The limit on one of my credit cards currently is three times what I make in a month, and they know that – the credit card company analyzed my finances before approving me for the card. I have a dangerous weapon in my hand with that credit card. I could, technically, spend three times what I make because of it! But I don’t. And neither should you. Just because you can qualify for a loan that is X size, that doesn’t mean you should take it. Ask yourself what would happen if one thing in your life changed financially. Like, your rent increases. Or you lose that side gig. If one change like that would make it hard for you to make your loan payment, then that loan is too big. Make sure you have wiggle room in your finances after making that loan payment.