August 2013

Choosing the Best Loan Terms Can Save You a Bundle

Anyone who has bought a new home and gone through the mortgage approval process should be familiar with the words "loan terms". But what about when you apply for a credit card or are in the market for a new car? Many consumers don't pay a lot of attention to all the fine print contained in a loan contract or credit agreement but this can end up being a serious financial mistake.

Any time you take on additional debt in the form of credit you will have to sign some type of contract or agreement. This is true whether you are purchasing a home, buying a car, applying for a credit card, or opening a store account. The terms and conditions of your loan agreement generally depend on a number of different factors. These are:

  • Your credit report. Potential lenders scrutinize your credit report which details your current and past debt. It normally contains information about your mortgage, any car loans, all credit cards, and any other type of loan, including the total amount owed on each account, payment history, and when each loan is due to be paid off. Your report can also include any State or Federal taxes which you owe.
  • Your credit history. Anyone who is considering lending you money (credit) wants to see a consistent payment history with very few, if any, late payments or missed payments. If your report indicates a solid pattern of timely payments, this clearly demonstrates that you have the ability to pay your debts and take your financial obligations seriously.
  • Installment credit history. Again, lenders are looking for a consistent payment history. They also look at the total outstanding balances of your credit cards. Having numerous credit cards which are all at their credit limits can significantly lower your credit score. Most experts recommend paying off the entire balance each month. If you are unable to do this, try to keep the outstanding balance at no more than 30% of your total credit limit.

Basic Loan Terms

It makes good financial sense to understand the different terms used in a typical loan contract. Familiarizing yourself with the various terms and conditions written into most credit agreements can hopefully help you negotiate a better deal. It could even help you avoid making a costly mistake.

  • Loan Term. The term of a loan is the number of months or years which you have to repay the loan. You always want to choose the shortest loan term that you can personally afford. Typically, the shorter your loan term the higher the monthly payments. Conversely, if you choose a longer loan term your monthly payments will be smaller but your overall cost will be greater due to increased interest payments.
  • Total amount of the loan. This is how much you will actually pay (monthly payments multiplied by the number of months in your loan agreement plus all interest charges and fees). Experts suggest choosing the loan which costs you the least amount of money overall. This will normally mean higher monthly payments but will cost you less in the long run. If you can comfortably afford to make the higher monthly payments this would be the smartest option financially.
  • Interest Rate/Annual Percentage Rate (APR). The annual percentage rate includes both the interest rate and all fees you are being charged while the interest rate is strictly what you pay in interest. The APR you are offered is generally determined by your credit score/history. The higher your score, the lower your interest rate. This is why it is so important to maintain a good credit history and keep your score as high as possible. With big ticket items such as a home or car, a lower APR can save you thousands of dollars in interest payments over the life of the loan.
  • Monthly payments. This is simply the minimum amount of money you are required to pay each month to keep your account current. You can always pay more than the minimum amount or make more than one payment at any time. Before signing a loan contract you need to be certain that you can afford to make the monthly payments. Whenever possible, choose a loan which offers a low APR and interest rate but has monthly payments you can easily handle.
  • "Interest free" loan offers. Some retailers advertise interest free credit for a specific amount of time. The terms can vary anywhere from three months to even two or three years depending on the amount of your purchase. Generally the monthly payments are extremely low with these special offers- so low that if you only make the minimum payment each month it will not be possible to fully repay the loan at the end of the interest-free time period.

This is how the companies make their profits. There is usually a large amount due right before the special deal ends and if the account isn't fully paid off, all the back interest which was deferred is now added to your outstanding balance. Also be aware that if you make one late payment or miss a payment during the interest free grace period your APR will usually convert to the default rate (very high).