7 Questions Borrowers Should Ask
Posted by Gail | Filed under Credit Wise
One of the things I learned working with people in debt is that folks love to enter into agreements with their eyes tightly closed. Whether they’re banking on their lender to be a good guy and treat them right, or they’re feigning an inability to understand the terms and conditions of their borrowing, these people are unmitigated morons. Lord love a duck! How can you enter into any arrangement without reading the paperwork. And how can you feel comfortable making a decision about who to borrow from if you don’t ask some questions first. Here are some questions to ask when you plan to borrow money:
1. What will my payment be? You need to be able to work the monthly (weekly, bi-weekly, whatever) payment into your cash flow without buggering up your spending plan. And that doesn’t mean cutting into the amount you’re setting aside for savings. If you can’t manage the payment easily, that’s a sign that you should not be borrowing. Assuming all your other costs are in line, stop borrowing when your payments are eating up more than 15% of your net income. However… and this is a big “however”… if some of your costs are already out of whack – if you have huge housing costs or big childcare expenses – you may not even be able to afford the 15%.
2. What will this loan end up costing me in the long run? If you don’t take the time to add up what the total cost of borrowing will be when you take out a loan you’re making like an ostrich and you’re gonna end up with buckshot in your beeehind. The best way to get the total cost of the loan is to ask the lender. You can do the calculation yourself by adding up the interest cost each month, but you’ll be off slightly doing it manually because interest is calculated on the declining balance.
If the lender says (in a deep, patronizing tone), “Well, since you have a variable interest rate, that will depend on what the rate is each month” ask for a calculation assuming today’s rate plus 1% for safety. Then keep your eye on your rate. Don’t be fooled into thinking that the “prime” rate a lender quotes you is the central bank’s prime… it isn’t. The lender’s prime is likely to be a couple of points higher. Ask specifically what the rate will be.
3. Can you get a better rate if you secure the loan? The interest rate on a secured loan – that’s a loan that has assets of some kind attached to guarantee the loan — is lower than an unsecured loan. So a home-equity line of credit that uses the equity in your home to secure the line is always cheaper than a line secured only by your signature (your promise to pay). When you offer to secure the loan you are giving the lender a legal claim to whatever you use as security if you default, which means the lender assumes less risk and you have to pay less interest.
4. How long will it take to repay the loan? I can’t tell you the number of people I’ve worked with who have no idea how long it’s going to take to get out of debt based on their current payments. This seems to be particularly true for people repaying student loans. They “settle” for the repayment amount they’re offered by the lender without ever figuring out how long it will take to get the loan paid off or how that will affect the overall cost of the loan.
Here’s a newsflash: the longer the term of your loan, the more interest you will pay.
5. Is there a penalty or fee if I want to repay the loan early? Once upon a time loans were completely open and could be repaid in full at any time. Not so much anymore. More and more lenders are charging a fee if you make extra payments or decide repay the whole loan off early.
6. If I miss a payment, how will that affect my interest rate? As the money rules have changed, lenders have become far less flexible and far more punitive for even small slips. If you miss even one payment you’ll likely see your interest rate increase by 2% or more. If you have a variable interest rate, lenders can raise your rates at any time with barely a hint so your very affordable line of credit could become an albatross in no time flat.
7. Must I buy loan insurance? Some lenders give you the option of buying life and disability insurance on your loan so that if you get sick and can’t work the loan won’t go into arrears and ruin your credit history. These insurance loan policies are usually quite expensive and should be avoided if at all possible.
May 13, 2010 at 7:04 am
I wasn’t aware about the value in securing a loan! Thanks for that. I was of a mind that a secured loan was like putting a lien against your house, and that terminology gave it a negative cloud in my head.
Sounds like it’s the way to go for homeowners who have to borrow, and who will be dutifully paying it back!
Thanks!
May 13, 2010 at 7:14 am
When I purchased my new vehicle last summer, I asked to have the death and disability insurance added to my payments, because you never know what could happen. I just did the math and when my loan is done I’ll have paid about $2,000.00 over 5 years. I’ll have paid more for the insurance than interest on the vehicle ( $850.00). Thanks for clarifying this for me!
May 13, 2010 at 7:18 am
Those are all the questions that we as lenders must address…getting the client to actually pay attention while you are talking is another story..lol…but, I agree that the BORROWER should be asking those questions and more questions if it is still unclear….I will even take the time to show them how a payment will effect their cash flow…get ALL the info, so you can make an informed decision that is best for YOU:)
May 13, 2010 at 7:20 am
I went through that checklist when I got an RRSP, I figured the money I’d make in the market would cover the cost of the interest on the loan. The Banking crisis hit and I was really hurting. There was no way the loan was a good idea looking back in hindsight.
regards,
Jason
May 13, 2010 at 9:24 am
I think, often, that people just exhale that they GET the loan and don’t ask the needed questions. On my first loan about 10 years ago I asked none of these. On my most recent loan last year, I asked a version of all but number 3. Now THAT’s progress for me me
May 13, 2010 at 9:29 am
@ MiddleClassMominToronto – People that loan money will normally give preferred rates if they have collateral backing the loan. For instance, credit card rates are as high as they are because in the event that you decide you don’t want to pay the lending institution has no recourse in terms of going after an asset. A collateral loan (car, house, etc.) has that asset backing it, when you don’t pay the lender can go after that asset. If a lender has an asset backing a loan and know they can take it if you decide to default on the loan, the risk on the lender is less which is normally why they give preferred (lower) rates.
Great post Gail
May 13, 2010 at 9:39 am
I can’t tell you how many loan officers have looked at me insanely because I’ve actually read the paperwork.
Yes, I’m going to read exactly what you told me it was. I don’t care that you’re a reputable bank and not some fly by night operation.
If my signature is on it, I’m reading it.
Although I must confess some of these questions are ones I don’t ask. The only one I care about is “can I pay it off early without any penalty” and the “interest rate” — I have *always* paid extra on my loans, and finished the terms earlier than stated.
Even when that extra was only change I collected in the jar and paid every couple of months — ever since the loonie and toonie, that change adds up fast! Especially as I never used change to pay for anything. Always a crisp $5,10 or 20 bill.
The satisfaction of knowing that you’re not doing the minimum, that you’re achieving things, feels amazing.
May 13, 2010 at 9:50 am
I’d like to add a few questions to that already excellent list.
- Can I make extra payments without penalty?
-Can I increase the monthly payment amount if I choose to? (For some loans, one the payment has been increased, it cannot be changed back to the original amount.)
May 13, 2010 at 9:50 am
Thanks for reiterating the last tip. People thought I was nuts not taking the life insurance on my mortgage, but I did a little research (it took very little digging really) and figured out that it was cheaper and more advantageous to get my own policy.
When we bought my husband’s vehicle, the salesman did a hard sell on the disability insurance and balked when I told him we already had our own disability insurance to replace our income should we be unable to work so we would have no problem making the car payment in that circumstance. The insurance for just the car payment cost about half of what it cost to replace my income! Yikes!
May 13, 2010 at 10:06 am
@ psychsarah – good job. I don’t know what ‘people’ you’re associating with but declining mortgage life insurance is right up there with declining credit card payment insurance in the ‘good moves’ department. I never understood why someone would pay the same premiums for increasingly less coverage (as over time, the mortgage goes down).
May 13, 2010 at 11:25 am
When we first got our mortgage, we knew little about insurance and such–so, when the bank offered life insurance to cover us, we gladly accepted. I can see the appeal in some respects–the payment never goes up, unlike regular life insurance–it’s basically just there to guarantee the rest of your mortgage gets paid off in the event of something untimely. However, we looked into life insurance on our own and switched over to it about 2 weeks later-the big deciders were a) having the payout amount remain the same, instead of going down; and b) having the money paid out directly to YOU (or your spouse) instead of going only to the mortgage. Then you can decide the best way to manage the money.
May 13, 2010 at 11:41 am
I hear you psychsarah! We run into it all the time too, even after I explain that we have more than enough to cover us in the event of an accident/death. They think that telling me I could keep THAT money for myself because THEY will take care of my mortgage/vehicle is a selling point? I smile, nod, and repeat (politely) again that I’m good with what I have, thanks anyway!
May 13, 2010 at 12:07 pm
Lord love a duck is going to be added to my vocabulary as it is an awesome phrase. Great tips Gail.
May 13, 2010 at 12:19 pm
I always thought that since I have a good credit score I would get the better rates and they would stay that way. When the economy tanked, the very good interest rate on my LOC was increased by 1%, just because. It was nothing I had done and I got a “nice” letter from the bank to that effect, they informed me that it was the economic times blah blah blah. So, if your good credit can’t protect you, what’s the point in borrowing?
May 13, 2010 at 12:32 pm
Any contract should be read! I work for a satellite TV company that has contracts, and do you know how many people sign the contract and then when they are trying to cancel say “I was supposed to read that?”
Good Points Gail, and I particulary like the part about being able to afford the payments without cutting into savings! We humans have a way of justifying when we really want something.
May 13, 2010 at 1:30 pm
[...] here to see the original: 7 Questions Borrowers Should Ask « gailvazoxlade.com By admin | category: disability insurance mortgage | tags: already-had, income, [...]
May 13, 2010 at 1:47 pm
@Sparky, you’re right! I remember a time when lenders tried to explain things to me and I just didn’t listen.
May 13, 2010 at 3:08 pm
Sparky, you sound like a great banker – one of the good ones. It’s unfair to tar all lenders with the same brush just because some of them don’t have any morals.
Keep doing what you’re doing – you obviously care about your clients. Good job!
May 13, 2010 at 3:15 pm
One thing to note. My particular Student loan was an Ontario Student Assitance Program loan. When payments came due, there was a great online tool they offered that helped you figure out how many years it would take to pay off the loan at the rates they “suggested.” Sure, $325 per month sounded manageable, until i discovered it would be 6-7 years at that price. I upped it by an extra $100, then discovered on my year end summary how little a difference that made. So I upped it again and am spending in my means, and I switched to paying it weekly, instead of monthly, so more of my money will go towards the principle instead of interest. It also helps me to manage my spending weekly. I just pay it off when i plan for the rest of the week. I will have paid off my student loan next summer, after only 3 years since graduation! At least they offer no penalty for upping the payments (I checked before doing it). So long debt!
May 13, 2010 at 6:00 pm
@ Heather
WHenever you make an extra payment, make sure it is noted that the extra is supposed to go directly towards the PRINCIPLE not the interest portion of any loan. Sometimes it is just a phone call, different lenders will require it in writing. I would confirm this over the phone as well, making sure to note who I was speaking with and when.
Esther
May 13, 2010 at 6:07 pm
My in-laws recently got a $250k-ish mortgage that will possibly run them double that after all the interest. Do people not realize how much a mortgage *really* is?
May 13, 2010 at 7:11 pm
On a slightly different note…
I just pulled my credit report, and received it yesterday.
Does anyone have an explanation as to why my mortgage wouldn’t be on there? It’s close to being paid off, but not yet, and it is held jointly with my husband…
Mostly everything else looks fine. I really don’t like Equifax’s format though — the way they indicate the date is inconsistent, and I have one date that I have no idea if it’s the year first, or the month… Is it 2008 or 2004… and considering I don’t recognize the organization, it’s a bit disconcerting… anyone recognize HOME TRUST ?
I figure lenders are always wanting to give me credit cards, since I apparently don’t have a mortgage
May 13, 2010 at 10:07 pm
E: For the government assistance student loans, there is no penalty to paying it sooner, and the interest is calculated daily.
You can even login to the account and see the interest payments drop with each month. But, since the interest accumulates daily, the interest will always get paid down with each payment made. As the principal goes down, so too does the interest – by making mid-month payments, the interest charged is less than it should be too.
I finished paying my loan off in just over 2 years by making extra payments halfway through the month (well, putting 40% of my take home pay to the loan also helped, once I got my emergency fund filled…).
May 14, 2010 at 12:13 am
Cas:
Somewhere (more than likely on this site) I learned something to the effect that ONLY the first name on the mortgage is reported. It sucks!
I hope that if one alternates the order of the names at every renewal, it rotates the names… Does anyone know?
May 14, 2010 at 2:12 am
[...] V-O gives us 7 Questions Borrowers Should Ask and I’d like to point out I discussed in my post Mortgage Insurance question number [...]
May 14, 2010 at 8:24 pm
Cas – Home Trust is a mortgage lender, did you get your mortgage through a broker? If it doesn’t match the details of your current mortgage does it match what you got initially? The other option might be that they offer a credit card with the mortgage and they are only reporting that.
Regarding reporting mortgages on the credit report — almost no institutions in Canada report them — I believe it has to do with them being secured, credit scores are supposed to be a valuation of unsecured debt, since those are just based on your promise to pay.
Given the formula that Equifax and TransUnion use anyone who had a mortgage would have really a crappy score due to outstanding debt amounts and debt utilization.
May 19, 2010 at 7:30 pm
Just read the list I’ve asked every question except number 6, only because I never thought I would/will ever miss a payment
May 25, 2010 at 4:28 pm
Two questions:
I have loan insurance and am half way through paying off a 25,000 consolidation loan. Is it possible to cancel it once you’d already agreed to it?
I will ask my bank this – but I was told that I could miss up to 2 loan payments and now I wonder if there is a penalty for that. There must be! Does anyone have experience with this?
May 25, 2010 at 6:57 pm
lauraloo, you can indeed cancel your insurance…just make sure that you are still well protected via other insurance before doing so…
if you “skip” loan payments they are just added to the end of the loan…you still pay back the original amount just over a longer period of time…
( I work for a bank)
December 16, 2011 at 1:06 pm
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