Applying for your first loan can be an overwhelming and sometimes confusing process.
In fact, there are a number of things you should do before you even start the process of applying for a loan. First, build your credit. The number one hurdle a young person will come across is not having established credit. A limited credit score will make it more challenging to be approved for any loan.
The second obstacle to overcome is finding job stability. Jumping from job to job throughout the college years does not allow for a steady income.
If you have a steady income and your credit score is good, you are on your way to receiving your first loan.
When you step into the office to talk about taking out a loan, MidWestOne bankers will ask you a variety of questions to decide your best course of action.
1. Do you know what a loan is? (A student loan is a loan.)
A loan is an arrangement in which a lender gives money to a borrower, and the borrower agrees to repay the lender with interest over time. Sometimes, a young person will come in and not know they already have a loan out in their name. Remember, a student loan is a loan you will need to pay back, even if it is currently in deferment.
2. What type of loan application will you need?
There are individual and joint loans. Only one person’s name is on an individual loan, in which case, he or she is the sole borrower and the only person responsible for repaying it. A joint loan is for two or more people, and both are responsible for paying the loan back.
3. Will you be using a co-borrower or co-signer for your loan?
While the preference would ideally be for an individual loan, there may be the need for a co-borrower or a co-signer. A co-borrower is someone who is jointly responsible to pay for the loan and is on the title of the property. For example, if a married couple comes in and is approved for a joint loan, their incomes together qualify them for the loan, and both are responsible for paying the loan back.
On the other hand, a co-signer is a second individual or party who also signs the promissory note or loan agreement, taking responsibility for the debt in the event that the primary borrower cannot pay. In other words, the co-signer is a guarantor of the loan.
With some loan requests, you will be asked to provide collateral for the loan. Collateral is an asset pledged by the borrower to secure the loan or other credit. The collateral is subject to seizure in the event of loan default and is kept for the entire term of the loan. Examples of collateral include real estate, automotive or a savings account, and must be a large enough amount to cover the entire loan.
4. Do you have any credit?
This is the most common thing young people do not have when applying for their first loan, and is also one of the most important things.
An established credit history is necessary to be accepted to for a loan. If you do not have a credit card, the lender can see if you have any store cards such as from a department store, that will give you a credit score. This will also allow them to determine if you have made those store card payments on time. Lenders may also see if you pay rent or if you live with your parents and pay them for rent. Any of these options, among others, help establish credit.
After looking at your credit, the next thing lenders will analyze is your debt-to-income ratio.
5. What is your debt-to-income (DTI) ratio?
DTI is defined as the percentage of your income used to pay your debt. At MidWestOne Bank, the debt-to-income ratio must be 42 percent or under. Your debt is your monthly financial obligations you must pay out of your paycheck every month, i.e. rent, student loan payments, store cards or a credit card bill. These payments are taken into account with your gross monthly income, and together, those monthly payments cannot exceed 42 percent of your income. The other 58 percent is used for your miscellaneous bills. Each financial institution sets its own DTI.
For example, if your gross monthly income is $2,000:
2,000 x .42 (DTI) = $840. In this example, debt payments should not exceed $840/month.
6. Can you afford this loan? How will you be able to pay for it?
If things seem to be lining up, your lender will ask for financial information, such as a checking and savings account statements to view your financial status. They will ask you how much you think you can afford as a payment. They will also take into consideration when you get paid during the month, job stability, payment size and what payment can fit into your monthly budget without putting a strain on you financially.
7. What are your spending habits? Do you have any wasted expenses?
Another thing lenders will examine is your spending history. Specifically, they will want to determine if your current spending habits match your income. Overspending is a major concern for first-time loaners, but this can be solved with a budget.
8. Do you have a budget?
Some people coming in for loans have budgets, but some have never had one. Having a budget allows you to see where you are spending, how much you are spending, where you are wasting money and where you can cut back to make the loan work as part of your monthly payments.
Once a loan has been approved, it is important to stay in contact with your banker and not be afraid to ask questions if you do not understand something about your loan.