A little education goes a long way when it comes to borrowing money. Indeed, those who know what to look for can potentially save big bucks on their next car loan, home mortgage, or personal loan. Money-wise consumers are also less likely to fall prey to predatory lenders.
“Consumers have to look out for themselves,” said Pamela Banks , senior policy counsel for the Consumers Union advocacy group, in an interview. “You should always comparison shop, but with loans that can be more difficult. You have to be sure you’re comparing apples to apples.”
The time that borrowers spend researching their loan options, learning their rights, and exploring the types of lending practices that are best to avoid, she said, is well worth the investment.
Part of that research, for some consumers, would be to weigh the cost of a private loan against the cost of borrowing from themselves.
For those with substantial retirement accounts or insurance policies that have accumulated cash value, this may be an option worth considering. Retirement account loans, when allowed by the particular plan, and cash value loans can be attractive. But there are also consequences. Many financial advisors caution against borrowing from retirement for current needs. And using a life insurance policy’s cash value, can decrease its death benefit, along with the cash value and increase the likelihood of it lapsing.
Get multiple loan offers
If the decision is to borrow externally, the first step to getting the best deal is to solicit loan estimates – in writing from multiple lenders.
Many consumer advocates suggest a minimum of three, but too many can be overwhelming. A smaller number of loans from high quality lenders, such as those that are FDIC-insured, can sometimes yield better results, said Banks.
“A bank or credit union may offer a lower rate than the car dealership,” she said, noting some banks will offer additional perks to win your business. “Get enough estimates from a variety of lenders to be sure you are getting the best information available and the best deal.”
Mortgages, for example, are generally offered by banks, credit unions, mortgage brokers, and online lenders. Borrowers should compare offers from both mortgage lenders and brokers.
To make it easier to compare loans, the Consumer Financial Protection Bureau (CFPB) recommends asking each lender for the same loan features, including term, or length of the loan, and down payment. In the case of a home mortgage, you should also include rate type (fixed or adjustable), rate lock period, and any points you may choose to pay to lower the interest rate on your loan.
Understand the fees
To adequately analyze your estimates, you’ll need to become conversant in the language of loans.
Most consumers focus solely on the interest rate, which is the fee lenders charge you for borrowing money. But the loan with the lowest interest rate is not necessarily the better deal.
The annual percentage rate (APR) is generally deemed a better yardstick for the cost of borrowing money, as it factors in not only the interest rate, but also any points, broker fees, closing costs and other charges you may have to pay.
The term of your loan is another important variable. Why? The longer you take to pay off your loan, the more you’ll pay in total interest.
Borrowing $20,000 for a car at a 4.5 percent interest rate for three years, for example, would cost roughly $595 per month, or $1,418 in interest over the life of the loan. By financing that car for five years instead, your monthly payment would be less (roughly $373), but the total interest you’d pay would be $2,372, according to Nerdwallet’s car payment calculator.
Consumers should also understand the difference between a fixed rate, in which the interest rate stays the same over the life of the loan, and an adjustable or variable rate loan, in which the rate you pay periodically adjusts based on financial market moves.
Many credit cards come with a variable rate, which can make carrying a balance more expensive in a rising-interest-rate environment.
In the case of a home mortgage, which is far more complex than a personal or auto loan, you should familiarize yourself with terms like "escrow," in which a third party holds money before closing, and the settlement fees you will be charged. Such fees may include the loan origination fee, private mortgage insurance (if your down payment is less than 20 percent), appraisal fee, title search and insurance, and points, which are fees paid to the lender at closing in exchange for a lower interest rate.
The other benefit of obtaining multiple offers is that it puts you in the driver’s seat, giving you leverage to potentially negotiate a better deal.
Most consumers are well aware that they can haggle over price, but they should also be aware that loan terms and features may be negotiable, too.
That includes the APR, term, whether or not there will be prepayment penalties, and any additional fees linked to the loan.
Auto buyers can potentially get add-ons such as extended warranties and credit insurance, alarm systems, and window tinting thrown in for less – or free. And the CFPB suggests not being shy about haggling with the dealer over delivery fees, document charges or origination fees, all of which can help lower the size of your loan.
Similarly, homebuyers may be able to negotiate lower fees for underwriting, application processing, attorney’s fees, and even courier charges.
The FTC further suggests that homebuyers ask whether a broker is involved, as it may not be clear whether you are dealing with a lender or a broker.
“This information is important because brokers are usually paid a fee for their services that may be separate from and in addition to the lender’s origination or other fees,” the FTC writes in its online consumer's guide “Shopping for a Mortgage.”
A broker’s compensation, the agency notes, may be in the form of “points” paid at closing or as an add-on to your interest rate, or both. According to the consumer guide, “You should ask each broker you work with how he or she will be compensated so that you can compare the different fees. Be prepared to negotiate with the brokers as well as the lenders.”
Know your rights
Anyone taking on a loan should also understand his or her rights.
The Equal Credit Opportunity Act prohibits lenders from discriminating against credit applicants based on race, color, religion, national origin, sex, marital status, age, whether an applicant receives income from a public assistance program, or because they have in good faith exercised any right under the Consumer Credit Protection Act.1
Similarly, the Fair Housing Act prohibits discrimination in residential real estate on the basis of race, color, religion, sex, disability, familial status, or national origin. 2
You cannot be refused a loan based on these characteristics nor be charged more or offered less-favorable terms.
If you think you have been discriminated against, you can contact your local fair housing agency, submit a complaint to the Office of Fair Housing Opportunity at the Department of Housing and Urban Development, or contact the CFPB.
“You always have to look out for yourself as a consumer,” said Banks.
Beware predatory lenders
Despite legal protections, however, predatory lending still exists.
Predatory lending is often described as deceptive, exploitative, or abusive loan practices, such as packing hidden fees into your loan, charging excessive points or fees, or focusing solely on the monthly payment rather than the other, less favorable features of the loan.
Other lenders trap buyers who are financially vulnerable into products like balloon loans, which offer a small monthly payment, but then require them to make a large payment at the end of the loan repayment period. In some cases, that payment is the equivalent of their entire loan balance.
A prepayment penalty attached to a loan can also put borrowers at risk if they sell their home or later have the financial means to pay their mortgage off early.
Your best defense against predatory lenders is, as always, a good offense.
“As you compare loan offers, ask what happens if for some reason you are not able to pay your loan back or you fall behind on payments,” said Banks, noting even the most financially prepared consumers can face financial hardship if they experience a job loss or unexpected medical bills. “Is there a penalty and if so how much? Will a single late payment ding your credit report? Do they have repayment plans so that if you do fall behind you can rehabilitate yourself financially and come out in good standing?”
If you’re looking to borrow money for a new car, house or personal expense, you need to know how to shop for a loan.
Research your options, solicit multiple offers, and don’t be afraid to play hardball at the negotiating table. Indeed, consumers who do their homework are more likely to land the best loans and keep unscrupulous lenders at bay.
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1 Department of Justice, “The Equal Credit Opportunity Act,” 2017.
2 Department of Housing and Urban Development, “Fair Housing – It’s Your Right.”