Deciding on a loan isn't easy, and it's not always about finding the lowest figure upfront. You also have to consider what you can afford to pay now and in the future, which means deciding on things that haven't happened yet.
While the decision is up to you, we can help you figure out just what you need to know to get started. The four basics to consider are — your history, repayment period, budget and risk factor.
Your loans are based on your history.
Your financial history informs credit lenders and providers, who decide what sort of loan to approve you for (if any). This history is made up of:
Your credit score.
A big part of your actual history is decided by this number — although lenders will read your full credit report before approving you too. For the best chance of success, you should aim for a score above 640.
Income and employment history.
Lenders usually want to make sure you're able to keep and hold a job. Although it is possible to get loans if you're not currently employed — you need to be able to prove some form of income, such as government assistance or other fund types.
Lenders also want to know you're not taking on too many debts. DTI (debt-to-income) ratio looks at how much pre-existing debt you have versus what you can afford to pay. Your current debt shouldn't exceed 36% of your total income. You can find your DTI by multiplying your total income by X (or how much more than the earnings you want to borrow).
Any down payment.
If you already have a sizeable amount ready in the bank, this can drastically change how much you have to borrow. This means you can take out a shorter-term loan (and save more when you do).
How long you take out loans will determine how much interest you pay and will be worked out on how much of a risk you pose of not paying the loan back.
How long can I take out a loan?
Some personal loans will advertise as buy now, pay later or short-term loans, where you're expected to begin repaying with the next paycheque. These may be for smaller ticket items, such as tv, sneakers, rugby tickets, etc. Usually, they'll run at a high-interest rate because there's often less restriction around credit checks, so add more 'risk' to the provider.
Longer-term loans will generally run at 6-12 months, or maybe even years (the average home loan runs around 30 years). Loan types differ depending on what you're after. They generally involve lower interest rates because of the long-term business involved and more stringent credit checks. But we're talking about a case-by-case basis here. The more expensive the item, the longer the loan term you'll need.
So how do I budget?
Budgets depend on what you can afford. To work out a budget, you have to figure out your outgoing costs and your income, so basically;
income - expenses = available cash
Then you take the amount you want to borrow, divide it over time you want to borrow for and multiply it by the rate of interest;
amount ÷ time x interest = loan
Your credit score and (for larger loans) deposit amount will determine the length of time and interest rate you can borrow.
Let's talk about home loans, for example. Depending on your credit score and deposit amount, you can often find low-interest rates — at least for the first year. First time homeowners — credit providers know you'll be locked into a thirty-year agreement, and so they may advertise interest rates around 1% for the first year to entice you to sign up. Also, some providers and banks are more geared towards first-time homeowners than others, depending on their policy. Don't stick with your bank just because it's convenient.
The longer the agreement, the more time interest has to add up. So it would help if you were aiming to pay back what you can within a specific timeframe. Calculate what you can afford each month to meet the goal of complete repayment if you can go in for a fixed-term loan, especially for longer goals like homeownership. That way your interest rate can't move around, even when market interest rates increase.
How to calculate risk.
Credit providers use a credit score based on your previous financial activity to decide how likely you'll be able to make repayments. Your credit score may even determine which loans get advertised to you. So, the more financially able you can show yourself to be (repaying credit on time and in total), the better loan deals you're likely to see in future.
There's a lot to consider when applying for a loan. What you can afford will depend on your financial activity and the amount of risk you pose as a borrower. The length of time you borrow for is also a massive component because that will decide how much interest you incur — but you'll have to make a budget to see how short a time you can affordably take out a loan for.