The Basics of Borrowing Money

As common as the act of borrowing money may have become, there are still very few sources that explain what happens when an individual applies for a loan. Banks and other private lenders explain certain details regarding the process but tend to only focus on the obligations of the borrower, not on how the system itself works. The same can be said when talking about online lending platforms, however, these often offer smartphone apps that guide the borrower through the entire process and also explain each step.

This having been said, as far as traditional lenders are concerned, the act of borrowing money and the loans are mostly the same. Here is what you need to know:

You Have a Credit Score and It Matters

All official financial decisions and information of an individual are stored in his credit file. The collected data can then be used by lenders to calculate a credit rating for that individual. This score is extremely important and plays a part in establishing whether or not he will be allowed to borrow money from banks and other private lenders. In many ways, this credit score gives lenders information regarding how an individual manages his personal finances and how he pays his debt.

Furthermore, the credit score is also used to establish the exact interest rate that an individual will get as part of his loan agreement, as well as whether or not the loan will be secured or unsecured.

There Are Two Main Types of Debt

From a functional point of view, there are two main types of debt: secured and unsecured. As the name implies, secured forms of debt need additional insurance for the lender. This means that for an individual to take out a secured loan, he will have to offer his personal property as collateral. In most cases, the preferred form of collateral is the borrower’s home, but some lenders will also accept other types of high-valued property.

Secured forms of debt have larger value limits, which means that individuals can borrow more money, and come with lower interest rates. The low cost of the debt can usually be explained by the fact that secured loans are safer than unsecured ones.

young angry and worried man working with laptop at home looking at bills and paying bills in home finance concept

The Credit Score Is Built Up Over Time

For the most part, it is impossible to increase your credit score in a short time. This is a because most of the data that goes into calculating it comes from long-term financial affairs such as how fast an individual repays his debt, how many times he uses his credit card over 12 months, how much of the credit that is available to him he is using at any given time, etc.

However, making poor financial decisions can have a sudden negative impact on your credit score. For example, missing a loan repayment, taking out a payday loan right after submitting an application for a large personal loan, or maxing out a credit card.

Not Being Able to Repay a Loan Is Not Always Dangerous

Most individuals tend to avoid secured loans because they are afraid of what could happen if they don’t manage to repay the money on time, however, banks are usually very understanding in extreme scenarios.

Banks will always prefer to get their money back rather than take possession of the borrower’s property. As a result, the lender will first sit down and negotiate with the borrower to find a mutually agreeable way to repay the loan. The bank will take possession of the collateral only as a last resort and only if the borrower does not cooperate.

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