Whether you want to start building a solid credit history, buy a new house, or launch a business, there are many different reasons you might need financing. Borrowing money is a big commitment, and there’s a lot to take into consideration before you sign on the dotted line.
Here’s what you should know before applying for a loan or credit card:
1. Financing Should Be Necessary or Helpful
Every time you apply for a credit card or loan, the lender makes what is known as a “hard inquiry” to check your credit score. These hard inquiries can temporarily ding your credit, so make sure you only apply for what you need. Don’t reply to all the credit card offers you receive in the mail. Be selective and only apply to an offer if it will help you meet your financial goals, and if you’re in a good position to take on credit.
2. You’ve Got Options
There are two basic types of financing: secured and unsecured. A car loan and mortgage are the most common types of secured loan. With a car loan, if the borrower fails to make timely payments, the loan issuer can repossess the vehicle. Similarly, with a mortgage, the lender can seize the property and sell it to recoup the funds owed.
On the other hand, an unsecured loan is not protected by any collateral. The most common types of unsecured debt are credit cards, student loans, and personal loans. Unsecured financing can be harder to obtain, and may cost more, since it is a higher risk to the lender. If you default on the loan, the lender can’t automatically take your property.
If you’re just starting out, you might want to try applying for a secured credit card first. Secured credit cards are designed for people with damaged credit or no credit. To open your account, you’ll need to put down a cash deposit (usually $200–$500), and your credit limit is typically equal to your deposit. Charges aren’t deducted from your security deposit, so you will have to make monthly credit card payments in order to start building your credit. With a low $5 annual fee, USE Credit Union’s secured Credit Builder credit card is a great way to get started.
3. Your Credit Score Matters
A good credit score and credit history show lenders that you are responsible and make your payments on time. In general, a credit score near 700 or higher is considered good, while 800+ is excellent. The better your credit, the more likely you are to obtain a loan with the most favorable interest rates. Even a small difference in terms can save you thousands of dollars in interest over the life of your loan.
Before you apply for a loan, consider checking your credit reports for errors that could drag down your score. If your credit isn’t in great shape, take steps to start improving your credit first. Pay down other debts you may currently owe, and make sure you remain current on all payments.
4. DTI Is Very Important
In order to be approved for a loan or credit card, you need to prove that you have the ability to repay what you borrowed, now and in the future. When you apply for financing, lenders will evaluate your DTI, or debt-to-income ratio, to help determine the risk associated with lending to you.
DTI compares how much you owe each month to how much you earn. Specifically, it’s the percentage of your gross monthly income (before taxes) that goes toward your monthly payments for rent or mortgage, credit cards, and all other debts, including student loans or child support. You can use USE Credit Union’s online calculator to determine your DTI.
Although the range of acceptable DTI ratios varies based on the lender and type of loan you are applying for, borrowers with lower DTIs are more likely to be approved. A high DTI ratio can indicate that a potential borrower has too much debt for the amount of income earned each month and might not be able to pay off a new loan. A good rule of thumb is to keep your DTI under 33% so that you don’t overextend yourself financially.
5. Financing Costs May Affect Your Budget
When you borrow money, whether you commit to a car loan or open a new personal loan, there is an APR, or annual percentage rate, attached to the loan. APR is the lender’s financing charge that’s applied on top of your principal (the actual amount you’ve borrowed) and is stated as a yearly rate. For installment loans, such as personal loans, mortgages, or auto loans, part of your monthly payment will go toward the principal as well as interest.
For revolving lines of credit such as a credit card, you will only pay interest on balances that you carry from month to month. Therefore, it is possible to avoid paying interest on your credit card by paying it off in full each and every month.
There are other fees associated with credit cards, but many of these are also avoidable. For example, some cards charge an annual fee to cardholders, but do your research and you can find a credit card without an unnecessary annual fee. In addition, late fees are charged when you pay late by even a day or if you don’t pay at least the minimum amount due. Of course, late fees won’t be an issue if you pay on time.
Keep in Mind
Responsibly using debt can help you establish and maintain good credit. Just remember to pay in full and on time every month. If you pay 30 or more days late, your payment will be recorded as late on your credit reports, hurting your credit score.
In addition, stay well below your credit limit and don’t max out any credit cards. Using too much of your available credit will also negatively impact your credit score.
We Can Help
As a member-owned financial institution, USE Credit Union can help make your financial dreams a reality. Whether you are shopping for a new house or a new car, we have affordable loans to meet your needs. And, we also offer Credit Cards with competitive low rates, a great rewards program, and low fees.
Not sure what’s right for your situation? Reach out to our team.
All loans subject to credit approval. Rates, terms and conditions subject to change. This content is for informational purposes only and is not intended to be financial advice.