Investing in the future is expensive. Be it an education, a home or a car, sometimes a loan is the only option to get a hold of a big-ticket item. As a young person, it can seem almost impossible to get approved for a loan without parental support. That's why understanding the ins and outs of the loan process can be essential to getting that check from the bank on your own. (To read more articles devoted to young adults, see Portfolio Management For The Under-30 Crowd, Competing Priorities: Too Many Choices, Too Few Dollars and Retirement Savings Tips For 18- To 24-Year-Olds.)
The Loan Process
When thinking about getting a loan, it can be important to look at the situation from the bank's perspective. To the bank, loans are a major source of revenue. The bank cuts you a check for a certain amount of money (principal), and you give the bank that same amount of money back as well as the interest that is charged for the privilege of letting you have that money. Interest payments are the lifeblood of most banks. (For more on this topic, see Analyzing A Bank's Financial Statements.)
Loans aren't hand-outs, and they shouldn't be approached as such; a bank's primary concern is determining whether or not you will be able to pay back your debt based on its time frame and agenda.
Banks judge potential borrowers based on a number of key things. Among them:
- Who: Who are you? What do you have to offer the bank?
- What: What's the money for? A bank is a lot more likely to lend money to someone who wants to build a home addition (and add equity) than someone who is planning on spending the money on consumption or disposable goods.
- Where: Where you're trying to get your loan from can be a big factor of whether or not you get it. Lending criteria can vary between a brick-and-mortar bank and an online financial institution as well as between various geographic regions - some lenders are going to be more prone to give than others.
- When: The length and terms of the loan - both the interest rate and the duration of the loan - determine when banks can start recording a profit and also how much profit it will reap.
- How: Can the bank be sure that you will be able to pay the loan off based on the terms? How can you guarantee payback or at least hedge the bank's risk in some way?
Who You Are
Who you are is actually an important element of whether the bank will see you as a viable borrower. Believe it or not, you're being judged from the moment you walk in that door based on one of the few tools the lender has - your appearance. So dress the part: If you want to be treated like a professional, dress like one.
Right or wrong, the lender will use their biases and preconceptions in determining whether you're a good risk for the institution to take on. Also, don't be surprised if the bank does a background check on you. They will certainly be checking into your credit history. (To read more about credit, see The Importance of Your Credit Rating and Credit, Debit And Charge: Sizing Up The Cards In Your Wallet.)
What You Plan to Do
Since it's the bank's money, it's also the bank's business as to what you're planning on doing with it. If you need a bank loan to fund your gambling habit, chances are you won't be getting much in the way of financing.
If, however, you're trying to purchase or improve an asset - like a car, a home or your business - banks usually see this as a point in your favor.
Where You Plan to Borrow
These days, there are alternatives to getting a loan from a traditional bank. Online lending is quickly becoming a popular option because of higher online competition and quicker loan approval. With online lenders, fraud-awareness and reputability become major concerns. Always make sure that you're only dealing with reputable companies and not readily giving away private information to non-secure or irresponsible companies. (To make sure you avoid online scams, see Online Investment Scams Tutorial and 10 Things To Consider Before Selecting An Online Broker.)
Where you are in the world can also have an impact on loan approval. This is a matter of scarcity. If you're trying to get a loan in an economically depressed area, banks are bound to be much more selective about who they loan money to than in an area of vast economic growth. By taking this into consideration, you can get a much more realistic view of your prospects.
When You Pay
When it comes down to deciding which loan to accept (or in the case of the bank, what to offer), the terms of the loan are the biggest factors. Some of the items that can vary are the interest rate, the length of the loan and the type of loan.
Interest is the premium that you're paying to the bank for the use of their money, so lower interest rates are better for borrowers. The duration is the amount of time you'll be paying off the loan, so once again, a smaller number is better - this will mean a lower overall interest expense.
The type of loan you're looking at is also significant because it can be a big factor in the amount of money you pay during each payment period.
How They Decide
The bank isn't going to give you a cent if you don't have the means to pay it back later (or if you don't have enough assets for the bank to get their money back). That's why they look at a few key things about your financials:
- Collateral - What major assets do you have that the bank can seize if you default on your loan? Typical collateral includes your home or your car. This will also take into consideration what you are using the borrowed funds for, such as a house, which would be collateral to the loan.
- Credit - Your credit absolutely comes into play when you apply for a loan. If you have bad credit, getting a loan is going to be difficult unless you are willing to accept less attractive loan terms (like higher interest rates and lowered limits).
- Income - Your lender is going to want to make sure that you can afford to make payments on your loan. Higher income translates to lenders being more comfortable with letting you borrow money. (For more information, see Invest In Yourself With A College Education.)
If you don't seem like a picture perfect loan candidate, getting stuck with higher interest rates and fewer loan alternatives is more than likely. And if you have few assets, bad credit and/or are barely scraping by, chances are that lenders won't be calling you back.
Make Yourself Attractive to Lenders
The best way to make lenders fight over you is to make sure that you address each of the five things in a positive way.
- Who: Dress the part when you go to apply for your loan and make sure that you don't have any skeletons in your closet that lenders won't be happy to see.
- What: Lenders don't just give money away. Make sure that your need is legitimate and financially justifiable.
- Where: Look into online lenders you're interested in to make sure that they're reputable and try to avoid looking for financing in areas where bank money is scarce.
- When: Only go for loan terms that you can live with, and understand what you're going to end up paying out over the life of the loan.
- How: Think about what assets you have that can be used as collateral, build up good credit before you go to a lender, and make sure that you have a viable plan for loan repayment.
Let's face it, the reason that young people typically need a co-signer for a loan is because a co-signer typically has the five things banks are looking for. When you know what lenders look for, as well as what you can do to make sure that you look like a responsible borrower, it's quite possible to get a loan without your parents' signature and without sky-high interest rates.