How to Avoid a Bad Loan

As the market for sub-prime lenders (or lenders that borrow to those with poor credit) continues its decline, it's important to know the risks associated with taking out certain types of loans. Not only are you risking the security of your loan with certain lenders, but you're also risking your financial security depending on the loan you get. Knowing if you should apply for a personal loan, home equity loan, or mortgage refinance loan can mean the difference between thousands of dollars in fees and monthly payments. Below are common types of loans and benefits/risk associated with each. 

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Loan Types

1)  Mortgage Refinance Loan

This loan type is used mainly to lower monthly payments on an existing home mortgage. Reasons to apply for a mortgage refinance loan include finding a better rate or using the equity in your home to get additional cash out. Benefits may include tax deductible interest, lower monthly payments to ease the burden on your wallet, and a fixed rate over many years. Depending on your situation this may be a wise choice for staying within your budget each month with a payment that's "locked in" for a set amount of time. One risk to be wary of is that which comes with the ARM mortgage, or adjustable rate mortgage. An adjustable rate mortgage may give you a small monthly payment for 1-5 years, but after this period the rate adjusts upward for the remaining loan term and your monthly payment can increase substantially. 

2) Home Equity Loan
A home equity loan, sometimes referred to as a debt consolidation loan, is a loan taken out against your existing home. This loan is in addition to your primary mortgage and typically is offered at a higher interest rate. The amount you can borrow depends on the total equity in your home. Many people use these loans for home improvement projects or to consolidate higher-interest debt from credit cards or other loans.  Benefits to a home equity loan may include tax deductible interest and only paying interest on the loan for a set period of time.  With a mortgage refinance loan you usually pay interest plus principle but with a home equity loan the principle payment is not always required up front. One important risk to note with this loan type is the variable interest rate.  A HELOC, or home equity line of credit, is one version of this loan where the rate can adjust as frequently as every month. When you're on a budget this can be a big blow if rates go up. A fixed rate home equity loan is similar to a first mortgage, where rates stay mostly the same each month. However, a fixed rate loan does usually require principle payment as part of the monthly amount due.  

3) Personal Loan (unsecured or secured)

Unsecured (renter personal loans) or secured (homeowner personal loans) offer a flexible and fast option for obtaining lower loan amounts, but can carry higher interest rates. Personal loans can be used for debt consolidation if you hold several credit cards with higher interest. Many times these loans also fulfill the purpose of money for unexpected expenses, or as emergency funds. Rates will vary depending on your credit profile (excellent, good, fair, and poor).  Credit can be affected by your payment history on other loans, but when you apply for a personal loan usually you will get an indication of the rate you qualify for. 

Be informed when you apply for a loan online!