When people talk about the American Dream, it’s hard to do so without thinking about debt. For all the homes and cars and colleges available to us, we still have to pay for them. And doing so in cash is close to impossible for the average American.

 

I speak with people every day about their financial goals, and what I have found is there are two main reason’s for their desire to improve their credit scores- to acquire a home and auto loan.

Who can blame them? Everyone needs reliable transportation and comfortable living space. But, knowing that a loan is necessary, are we considering the cost in it’s entirety?

It amazes me when I speak with people, and I they don’t know the amount of interest they are paying on their loans. It amazes me even more when people don’t shop around or prepare themselves for this financial commitment. A home and a vehicle are 2 major purchases that most people will make in their lifetime. Shouldn’t it be best to be prepared? Well, let’s dig deeper to outline what an interest rate is, and how you can ensure you snag the lowest one possible.

What is an interest rate?

When a borrower takes a trip to their bank to borrow money, he is charged an interest rate- a fee the borrower pays for the ability to spend money now, rather than wait until he’s saved the same amount. Interest rates are expressed as an annual percentage of the total amount borrowed, also known as the principle. For example, if you borrow $1000 at an annual interest rate of 9%, at the end of the year you’ll owe $1,090.

FYI- Interest rates aren’t a punishment for borrowing money. The interest a lender receives is his compensation for taking a risk. With every loan, there’s a risk that the borrower won’t be able to pay it back. The higher the risk that the borrower will default, the higher the interest rate.

Know your credit scores.

When a lender receives a loan application, they are (in most cases) looking for reason to approve you for the loan. Your credit score is the first place they start. Your credit score is a representation of your money management habits. It tells a lender how likely you are to repay your loan. The higher your score, the less likely you will be denied. Granted, some loans are easier to acquire than others. But, you can be certain your credit score will be taken into consideration.

This reason alone is why I strongly encourage knowing your credit scores before ever contacting a bank. Knowing your credit scores gives you the control over what bank you will do business with; not the other way around. You want the lowest interest rates, right? You want to get approved, right? If, so, never go to a bank without doing your homework first. There is absolutely no reason a lender should know your score before you do.

Reduce your debt.

Debt can be easy to get into, but a hassle to get out of. Banks know this, and they take it into consideration when evaluating your application.

Your debt-to-income ratio can get you a denial if it’s not being managed. What we recommend is keeping your debt-to-income ratio at 30% or less. What does that mean? For example, if you pay $500 a month for your student loans, another $500 a month for an auto loan, and $400 a month for the rest of your debts (credit cards, personal loans, etc), your monthly debt payments are $2000. If your gross monthly income is $4000, then your debt-to-income ratio is 35%. This may get you denied. Focusing on reducing your monthly debt or increasing your income will reduce your debt-to-income ratio, and get you the approval you want.

Simply put- reduce your debt before getting into more.

Bottom Line

Get informed and shop around before making any long-term financial commitments. A loan is a serious decision; therefore, serious consideration should be made about every detail. Your goal should be to secure the lowest interest rate as possible when borrowing money. Raise your credit scores, pay off your debt, and do business with the a financial institution that will help you attain the American dream without breaking your bank account.

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