Perhaps you’re getting ready for your first semester of college. Or you want to finance new appliances for your kitchen. Or maybe you want to consolidate your credit cards. Whatever the case may be, you may be considering taking out a loan.
If you’ve never shopped for a loan before, the process can seem overwhelming. But it’s simpler than you may think.
When you borrow money — whether it comes from a bank or a friend — and agree to repay it, you’re taking out a loan. Loans come in many different forms, but they are most often issued by banks, credit unions, and online lenders.
Loans can be divided into two categories:
Secured: With a secured loan, you put your property, such as a car or house, as collateral on the loan. If you default on the loan, the lender can seize your property and sell it to recoup its money. Common forms of secured loans include auto loans and home equity loans.
Unsecured: Unsecured loans don’t use collateral. Instead, the lender decides to give you a loan based on the information on your credit report and your income.
Throughout your life, you may need to take out many different types of loans. Here are the five most common loan types and how they work.
Personal loans are usually unsecured, and they can be used for a variety of purposes, including:
Personal loans are installment loans, so you make monthly payments for a fixed term, such as two to five years.
When applying for a personal loan, you usually will need good credit or excellent credit to qualify for a loan. According to Equifax, one of three major credit reporting agencies, that means you need a score of 670 or above.
If your credit score is lower than that, you may need to ask a friend or relative with good credit to cosign the personal loan application with you to get a loan.
An auto loan is a loan you take out to purchase a new or used vehicle. They’re a form of secured debt; if you default on the loan, the lender can repossess the car and sell it to recover the money it lent to you.
Auto loans typically have terms between two and seven years, and you make monthly payments for the duration of the loan.
Student loans are unsecured loans you take out to pay for college. They can come from the federal government or private lenders. Interest rates and repayment terms vary based on the type of student loan you take out, but they’re generally repaid over 10 to 25 years.
A mortgage is a specific type of loan you use to purchase a home. They are secured loans, with the house serving as collateral for the loan’s repayment.
When you apply for a mortgage, lenders will look at several factors when determining your eligibility for a loan, including:
Credit score: Although there are some mortgage options for borrowers with poor to fair credit, lenders typically want borrowers with good credit and a history of on-time payments. Aim for a credit score of 670.
Length of employment: Lenders want to make sure you can afford your payments and have a history of steady employment and reliable income, so they will look at your employment history and pay stubs.
Assets: Buying a home is expensive, and lenders want to ensure you can afford your payments. They will consider your assets, including how much money you have in savings and investments, to determine your eligibility for a loan.
Debt consolidation loans are a type of personal loan that is specifically used to consolidate high-interest debt. Most commonly used to consolidate credit card balances, debt consolidation loans combine your existing debt into one loan. If you have good credit, you can qualify for a loan with a lower rate than you have on your credit cards, allowing you to save money and pay off your debt faster.
Before filling out any loan applications, it’s important to understand the total cost of borrowing money.
When you’re shopping for a loan, you’ll see that lenders list the loan’s annual percentage rate (APR). It is a percentage that represents how much you’ll pay in interest and fees over the course of one year. In short, the APR is the cost of borrowing money.
Now that you know the basics of borrowing money and the most common loan types, you can start the process of getting a loan. It’s easier than you may think; you can take out a loan in just seven steps.
First, think about how much money you need to borrow. Although it may be tempting to borrow more than you strictly need, keep in mind that borrowing more money will cause you to have higher monthly payments. And, more interest will accrue over time.
A good starting point is to create a budget. You can see how much money you have left over after covering your essential and variable expenses; the remainder is how much you can afford to pay in monthly loan payments.
Before you apply for a loan, you want to make sure your credit report is as strong as possible. Any incorrect information, such as fraudulent accounts opened under your name, can damage your credit.
Many people don’t realize it, but you have three credit reports. One with each of the three credit reporting agencies: Equifax, Experian and TransUnion. You can view each of them for free at AnnualCreditReport.com. If you find incorrect information, you can dispute those accounts with the credit bureaus online:
In the past, you could only view a credit report from each of the three major credit reporting agencies once per year at no charge. But due to the COVID-19 pandemic, the credit reporting agencies allow customers to view their credit reports weekly for free.
Next, think about the type of loan you need. The type of loan you choose will affect the available interest rates and fees. For example, these are the 2022 average interest rates for the most common types of loans:
New car loans: 5.50% with a 60-month term
Credit cards: 16.27%
Personal loans/debt consolidation loans: 10.16% with a 24-month term
Mortgages: 6.31% for a 30-year fixed-rate loans
Eligibility requirements, rates, and terms can vary a great deal between lenders, so it pays to shop around. Many lenders have prequalification tools you can use to get quotes without affecting your credit score, so that can be a useful way to compare loans from multiple lenders.
When evaluating your loan options, consider the following:
APR: The APR affects your total loan cost. In general, the lowest APRs are for borrowers with excellent credit that opt for shorter loan terms.
Fees: Some lenders charge added fees, including origination fees or disbursement fees. Be sure to check the lender’s advertiser disclosure to see what fees it charges.
Monthly payment: Your monthly payment is typically fixed, so you want to make sure you can comfortably afford it with your current budget. At the same time, you don’t want to make your payment too small. While a longer loan term will give you a smaller payment, you’ll also pay more in interest.
MyCreditUnion.gov has several calculators you can use to estimate how much you’ll pay on your mortgage, personal loan or car loan.
Whether you’re applying for a personal loan, home equity loan or a car loan, you’ll need to provide a significant amount of documentation. You can save time by collecting the following documents before starting the application process:
Identification, such as a driver's license or passport
Proof of income, such as recent pay stubs, W-2 forms or tax returns
Recent bank statements
Next, you’re ready to fill out the loan application. While many lenders allow you to apply online, some require you to call or visit a branch location, so contact your selected lender to see what its requirements are for new borrowers.
The application will ask for your personal information, including:
Social Security number or individual taxpayer identification number
Employer contact information
Desired loan amount
Intended loan use
The lender will also ask you to consent to a hard credit check. Hard credit inquiries can cause your credit score to drop by several points, so only apply for new credit when you really need it.
Depending on the type of loan and the lender, you may receive a decision within minutes. Or, it may take days or even weeks for the lender to process the application. The lender will notify you about its decision.
If you’re approved, it will tell you what the next steps are to accept the loan. If you’re denied, the lender will send you a notification with the reason for the denial.
If the lender approved your application, you’ll get a notification and a loan agreement. Review the loan agreement carefully and make sure the terms and conditions of the loan match what you expected. If you agree to its terms, sign the agreement and return it to the lender.
The lender will then disburse your loan funds, and you will have to start making payments toward the loan per your repayment schedule.
Check to see if your lender offers any interest rate deductions for signing up for automatic payments. Some lenders will reduce your interest rate by as much as 0.50% by signing up for autopay.
That's it! Now that you know how to get a loan, you can start shopping around for the best deal. Make sure you read all the small print and know how much you will be paying back in total, how long it will take, and how your credit score might be affected.
The views expressed are generalized and may not be appropriate for all readers. Acorns is not engaged in rendering any tax, legal, or accounting advice. Please consult with a qualified professional for this type of advice.