Since credit is borrowed money, any type of credit—including loans—comes with risks and potential consequences. For example:
Jaden is halfway finished paying off a loan he had taken out to help pay for his insurance. At the time he agreed to the loan, he was able to plan his budget and was making his loan payments on time. However, he has recently lost his job and is struggling to keep up with the loan payments. If he cannot continue making his payments to the lender, they can send his debt to a collection agency, ruining his credit and his ability to take out a new loan in the future. What other risks are involved with taking out loans?
There are many different types of loans, each with its own specific risks. However, in general, loans come with 3 major risks. Click each tab to learn more:
This is the largest risk to taking out a loan. As you saw with Jaden, there may be factors out of your control that prevent you from paying your loan. If this ever happens, contact the lender; they might be able to help you consolidate the debt into another loan.
If you have a loan which requires a large monthly payment each month, that means a large portion of your income each month is spent paying off debt rather than on things that may help you accomplish your goals. To avoid this, create a budget, and make sure your debt is manageable.
Some loans will significantly increase your debt-to-income ratio if you borrow an amount that is too large compared to your income. The higher debt-to-income ratio may possibly prevent you from taking out another loan until the first one is fully paid off.
So, let's say Jaden cannot finish paying off the loan and has begun missing payments. What will be the consequences?
Every loan comes with a loan agreement, an official document stating what the borrower and lender have agreed to. This includes the consequences for missed and late payments. Before you enter into a loan agreement, always make sure that the interest fees and monthly loan payments fit within your budget as best they can.
Every loan agreement states that, when someone is consistently making late payments or missing payments altogether, the lender can declare that loan in default. This means that the borrower has failed to pay back the debt. When default occurs, the lender may decide to sue you or seize your personal assets, or your debt may be sent to a collection agency. On top of that, if a loan defaults, it will lower your credit score and will be displayed on your credit report. It is harder for anyone who has defaulted on a loan to get another loan until the default is off their credit report.
Question
What should you do before signing any loan agreement?
Double check the monthly loan payments to make sure they fit within your budget over the term of the loan. You do not want your debt-to-income ratio to increase a lot after taking out a loan.
