Loans of June 2023 in the U.S.

What is a loan in the USA?

Taking out a loan stands for a financial operation that takes place when a lender (usually a financial institution, a corporation, or a government) provides funds (usually a certain amount of money) to a borrower (individuals and entities) in exchange for a certain interest.

Loans can be originated for dozens of reasons, from investing and business ventures to education-related expenses and renovations. The consumer's willingness to borrow money is essential for the economy, and therefore people start spending more and stimulating the demand. Businesses, for their part, start taking loans to expand their production. Overall, the economy is growing, and standards of living are improving. That is why the government is always trying to provide the most favorable loan terms during economic downturns.

A loan traditionally consists of two parts:

• the loan's principal —the initial size of a loan
• the interest rate —the cost of borrowing the principal

By signing the loan agreement, a person agrees to repay the principal of the loan and the interest over a specific period. There are two types of interest rates depending on the loan terms:

• A floating-rate loan implies the quarterly rate review for the whole loan period
• A fixed rate loan is adjustable, and it means that the interest rate will not change anymore

Although it may seem that the fixed rate loan is a better option, the risk of interest rates getting higher does not exist. Statistically, interest for a fixed rate loan is usually 1-2% higher than for a floating rate loan.

Loan payment terms may also differ depending on the type of a loan.

What are the major types of loans?

But where is the guarantee that the borrowers will pay back their debts to banks, smaller financial institutions, or other lenders? Here comes the moment to determine the difference between secured and unsecured loans.

Secured loans

Why should a bank provide any individual or entity with money and risk with its own assets? In the case of a secured loan, everything is clear. A borrower uses their property like a house (home equity loan) or a car as collateral to ensure the payment capacity. The risk for such a loan agreement is losing assets in case of non-repayment of debts. However, such loans are considered reliable, and therefore lenders are willing to provide their clients with higher amounts of money.

The most common examples of this type of loan are car loans or mortgages.

Unsecured loans

The other question is, what can encourage lenders to trust borrowers who cannot reassure their solvency with some estate, bonds, or other assets? A person who cannot use something as collateral can take out an unsecured loan. Such loans are riskier for lenders as any assets do not back them, and that is why their interest rates are higher and the loan amount is less. Usually, it does not exceed $5000.

The availability of issuing an unsecured loan depends on the borrower's credit history. Also, higher credit scores can qualify a borrower for lower rates, so it is worth getting the credit score in shape before applying for a loan. If a borrower has a good employment history and a long-standing relationship with a financial institution, a loan approval would not be a problem if they previously made the required monthly payments and paid all the debts on time.

But what happens if a person defaults on a debt? There is no collateral, so the lender can address the collection agency or even subpoena the defaulter.

The most common examples of this type of loan are personal loans.

Joint loans

The other peculiarity of lending is the availability of joint loans. Thanks to such an instrument, a person can share monthly payments with another borrower. Joint loans are usually borrowed by business partners, couples, or close friends. Taking out joint loans can be easier than originating a personal loan, as in this case, both applicants have equal responsibilities for the loan. Moreover, joint loans provide the co-signer with better options and could strengthen their credit history.

Incomes of most people usually do not allow them to make huge purchases such as buying a car or a flat at once. They need to save money for months or ages. However, for those who are not ready to wait for so long, there is always an option to take out a loan from online lenders or traditional brick-and-mortar financial institutions and use loan proceeds.

Five major existing loan categories can be allocated according to the loan purpose, and the most popular type is a personal loan.

Personal loans

Personal loans typically are borrowed for day-to-day reasons like paying medical bills or buying household appliances. Depending on the loan payment terms, the loan payment period may differ from 2 up to 5 years.

The alternatives to personal loans are

• payday loans
• credit cards

Payday loans

Payday loans are not considered the best option, as their interest rates can be up to 400%. Moreover, in case of not paying the debt on time, lenders can take money directly from the borrower's bank account.

Credit cards

The typical credit cards' interest rate is about 16%, whereas the average interest rate on a two-year personal loan is over 9%. So, personal loans are the chippiest option.

Getting a personal loan stands for an operation in which someone applies for a loan at a reputable lender, gets the money deposited into their bank account, and then makes fixed monthly payments (or there could be any other period).

In this category, loan amounts range from 1,000$ up to 100,000$ (usually for loans obtained for paying medical bills). The minimum loan amount of 1000$ is variable and depends on the lender.

Four most common requirements to get a personal loan in the United States

1. Credit history and score: It is necessary to have a credit history, and they usually request more than 600 points. It also helps to have a bank account already.
2. Minimum income requirement: Lenders will request documentation that proves that the minimum income requirement is met.
3. Debt to income ratio index: Lenders measure the ability to repay the debt considering various variables. The borrower's index must be less than 50% to be eligible.
4. Social Security Number: Most lenders require SSN, although there are options that accept ITINs.

Car loans

Commonly, car loans refer to the secured type of loans, as in that case, the car itself becomes collateral. However, some lenders provide an option to take out an unsecured loan for buying a vehicle.

Loan term lengths are 60 months for new cars and 36 months for used ones.

Various lenders can originate such types of loans. Typically, it is common to allocate financial institutions like national banks, credit unions, online lenders, community banks, and dealerships.

Currently, the average cost of a new vehicle in the United States exceeds $47,000. Whether someone applies for a loan through the dealership or at a bank, the lender will perform a credit check. There are other requirements for taking out a car loan, like having a minimum credit score. The threshold of a minimum credit score depends on the lender.

The origination fee is calculated as a percentage of the total loan for auto loans, usually between 1% and 2% of the loan amount. Minimum loan amounts for car loans areapproximately $5,000.

Student loans

Education in the USA is prestigious, and thus it is rather expensive. Students usually have to pay for tuition, books, fees, or campus accommodation.

According to statistics, nearly 70% of American students resort to credit usage and take out a student loan. For thousands of young people, a student loan is an opportunity to pursue higher education. The average loan amount of US students is about 30,000$.

Federal student loans

The first type of student loan is a federal student loan. Federal government finances federal student loans. In the case of federal student loans, there is no need to provide a credit history or a co-signer. To obtain a federal student loan, a student should submit the Free Application for Federal Student Aid or FAFSA.

Undergraduates can borrow up to $12,500 per annum and $57,500 total in federal student loans. Maximum loan amounts for graduate students reach up to $20,500 annually and $138,500 total.

The borrower's monthly payment can be 10% of discretionary income, but never more than they would have paid under the ten-year Standard Repayment Plan. Origination fees are currently 1.057% for federal subsidized and unsubsidized loans for undergraduate and graduate students.

Federal students loans are classified into three main groups for undergraduates:

Direct subsidized loans or direct loans

In such a case, the US Department of Education covers the interest rate during a certain period (up to six months after graduation). Such loans are considered the lowest cost, but there are some special requirements to qualify for a federal student loan. For example, a student should be an undergraduate, have a valid social security number, prove their financial needs, and be enrolled at least half-time at school-participant in the federal student financial aid program.

The interest rate for this federal student loan is 2.75%, and the origination fee is a little more than 1%. Also, in case of such federal student loans do not require a credit history or a co-signer.

To obtain a federal student loan, a student should submit the Free Application for Federal Student Aid or FAFSA.

Direct unsubsidized loans

Direct unsubsidized loans accrue interest rates and are available to graduate and undergraduate students. Also, there is no need to demonstrate the financial need to qualify. That is why such federal student loans are more popular among US students.

The borrower must be enrolled at least half-time as a regular student in a degree or certificate program at a federally qualified institution or university.

The student must be a USA citizen or permanent resident to qualify for federal student loans. Some private student loans can originate for international students in case of a creditworthy co-signer who is a USA citizen or permanent resident.

Unsubsidized loans have higher limits than subsidized ones, allowing students to borrow more money.

In the case of unsubsidized federal student loans, an independent college student may qualify for a higher loan maximum than a dependent college student.

The interest rate is fixed for the entire loan period. The current rate for direct unsubsidized student loans is 4.45%, and the current rate on unsubsidized direct loans for graduate or professional students is 6%.

If a borrower does not pay interest as it accrues, it is capitalized (it adds to the loan balance).

Direct PLUS loans for parents (Federal Family Education Loan)

The US Department of Education provides Direct Loan Program PLUS loans to eligible parents through educational institutions participating in the Direct Loan Program. Such federal student loans are also offered for graduate students or in a professional graduate program.

Direct PLUS loans program's first disbursements were made after July 1, 2021. The existing loan program offers a 6.28% interest rate, which is fixed and stays the same during the whole loan term length.

The maximum loan amount, in this case, is the cost of studying at the educational institution the child is going to attend minus any other financial aid the child receives. The educational institution determines the cost of studying.

The requirements for taking Direct PLUS federal student loans for parents are:

• The federal student loan applicant should be the biological or adoptive parent of a dependent undergraduate student enrolled at least part-time at a licensed educational institution. Grandparents (unless they have legally adopted the dependent student) or legal guardians are not eligible for a Parent PLUS loan, even if they have had primary responsibility for raising the student ;

• the federal student loan applicant should not have a negative credit history (unless there are any certain additional requirements);
• the federal student loan applicant should meet the general participation requirements of federal student aid programs

Private student loans

The second major type is a private student loan provided by banks, businesses, credit unions, and educational institutions. Taking out private student loans can vary widely between different lenders, and the loan term for a student loan is typically from 5 to 20 years.

Although this type of loan is not eligible for state financial aid programs, private loans can be refinanced. There is an option to lower the interest rate, depending on the borrower's income, credit score, and other relevant factors.

Private loans can also have variable or fixed interest rates and depend on students' or co-signers' credit scores. It is essential to pay attention to this detail before the loan acceptance to avoid a sudden interest rate beat.

Mortgage loans

A mortgage loan in the USA is a loan created to acquire or improve the living conditions of citizens, with an interest rate ranging from 3% to 5%. Also, in the United States, there are programs of the FHA (Federal Housing Administration) that facilitate the acquisition of a home.

Although there are many mortgage loans in the United States, the borrower can generally choose between loans with a fixed rate and those with a variable interest rate.

Home equity loan

The real asset itself secures a home equity loan. Usually, the borrower repays the loan by making equal monthly payments for a certain period. If the borrower can't afford the debt repayment, it's possible to lose the home in foreclosure.

That is why many lenders prefer originating loans for an amount that does not exceed 80 percent of the mortgage amortization on the house.

Many dishonest lenders are trying to betray their customers by hiding important loan details. It is important to know that a special cancellation rule exists to protect borrowers' interests.

This federal rule gives three business days, including Saturdays, but not Sundays, to reconsider a signed loan agreement and cancel the deal without penalty or fine. The Three-Day Cancellation Rule applies to various home equity loans. Anyone may cancel for any reason, but only if the borrower uses his primary residence as collateral. The right for cancellation does not apply to a holiday home or a secondary residence.

Debt consolidation loans

Debt consolidation loans were created to make the settlement of one's debt easier to handle. Instead of making several minimum monthly payments on various accounts, this repayment strategy involves obtaining a new loan to combine and cover the other loans or debts.

In other words, when the bank or another financial institution offers to consolidate debt and proposes buying the borrower's loans from other institutions. Thus, the bank gains a new client, providing him with better credit conditions.

Benefits of debt consolidation loans

There are several advantages of debt consolidation.

First of all, such a type of loan is useful in the case of short-term liquidity problems. For example, a person unexpectedly loses a job and can no longer fulfill all their monthly financial obligations. That is why debt consolidation is an alternative to reducing expenses.

Simultaneously, consolidating debt allows for streamlining the debts. Instead of having several different obligations with an extensive payment date system, this type of loan consolidates all of them in a single disbursement that can be strategically scheduled.

Another advantage of debt consolidation is that some financial institutions offer a grace period. The individual can unify his credits in April and schedule the first installment of the new loan for July. Thus, the user will not have to make any payments to the bank for three months.

The other advantage of debt consolidation is a grace period. Some financial institutions offer a grace period when a borrower does not have to make any monthly payments to the bank.

Moreover, some lenders can offer direct payment to creditors, assuming the client's responsibility.

How to apply for a loan?

We can break the entire loan origination process into six main stages.

1. Pre-qualification. A potential borrower will get the list of loan details and items needed to pick and submit to the lender during this stage. The list may include documents to prove the identity, income, address, monthly expenses, etc. Once the information is submitted to the lender, pre-approval arrangements get started.
2. Loan application. At this stage, a borrower completes the paper application or the electronic version of the application using a lending platform or a particular app.
3. Application processing. As the application is received by the credit department of the financial organization, it has to be checked for accuracy and comprehensiveness. An applicant should fill out all required fields correctly. Otherwise, credit approval may be challenging. The incomplete application may be returned to the client.
4. Underwriting stage. The lender runs the application by reviewing various components, including risk scores and credit scores. Also, many financial organizations have their own evaluation system with specific criteria that help measure the borrower's capacity to pay.
5. Credit decision (loan approval). After studying the detail, a lender decides to lend money or reject an application.
6. Loan funding. After the loan documents are signed, a lender may require additional time for legal and compliance reasons.

Then, borrowers receive their funds into their bank accounts and start paying the interest in line with a monthly payment during the first month.

What are the main requirements for obtaining a loan?

Age

Minimum age limits differ from one state to another. In most states, borrowers need to be over 18 years old, but there are some exceptions. In Nebraska and Alabama, it's necessary to be at least 19 years old. The highest age requirements are in Colorado and Mississippi (at least 21 for all types of loans).

Official identification

With this document, the bank or financial institution will be able to obtain more information about the borrower: name, address, and date of birth. The identification issued by the National Electoral Institute (INE) or a valid passport is required, and foreigners must have the resident card issued by the corresponding immigration authority.

Borrower's credit history

If a potential borrower hasn't established a credit profile yet, it's time to start one now. There is the main reason for building a good credit score: with a trustworthy credit report, you can qualify for a loan with favorable repayment terms and interest rates whenever it is needed. Lenders will check the credit report to determine the borrower's responsibility when handling his finances and financial obligations.

There are plenty of ways to build a good credit history. For instance, it is possible to obtain a credit card and make payments on time. Having multiple account types during the credit history is also important.

The three-digit score, sometimes known as the FICO Score, usually ranges from 300 to 850. Three major credit bureaus have scoring systems that differ from each other, and therefore the score you receive from each agency could be different.

Current employment info

The borrower's place of employment may have a direct impact on the loan originating.

Minimum annual income

The minimum income required for taking a loan depends on the lender. Usually, people with $15,000-$20,000 annually can look forward to receiving a minimum loan.

Payment history, tax refunds, and bank statements may also be required.

Ways to get a loan

We prepared an instruction for taking out a personal loan. Commonly, the requirements for other loans are the same, with a few differences.

Preparations necessary for taking out a personal loan

• Understand clearly which amount of money is necessary. The important thing here is that many lenders charge origination feesthat are taken out of the borrowed amount. Lenders apply a loan origination fee for compensation for the services they provide. Typically, the origination fee ranges from 1% to 10%, depending on the loan amount. Lenders discuss the loan origination fee at the beginning of the whole process.
• Understand any fees associated with a loan combined with an interest rate from the APRs (the annual percentage rates). This measure is used to calculate how much interest will be paid each month. Traditionally, APR ranges from 3% to 36% of the loan amount. Borrowers with excellent credit can look forward to having the lowest APR.
• Check the credit score: the borrower's credit score is one of the main factors when getting approved for a personal loan and in rate determination. It does not mean that originating a personal loan without excellent credit is impossible. However, personal loan applicants should adjust their expectations according to the credit score because it will be tough to get a personal loan if it is low. But don't forget even personal loan borrowers with minimum credit scores can always take steps to increase it.
• Find a lender: spend some time shopping for the appropriate lender. The personal loan provider should have a solid reputation, and it should fully explain all loan details. Some lenders may also provide you with guidance and other exclusive benefits.

Required documents

Once the borrower chooses a lender, they should start collecting their documents. Study the list of documents that may be required, but keep in mind that it may be wider depending on the lender you choose for originating a personal loan:

Identity documents: most personal loans require to submit one or more of the following documents:

1. Driver's license
2. Social Security Number (SSN)
3. Passport
4. The state ID
5. Military identification
6. Certificate of citizenship

Other government-issued identification documents

Confirmation of residence: personal loan borrowers may also be asked to prove their residential status by providing one of the following documents:

1. Utility bills (water, electricity, cable, etc.)
2. Rental agreement
3. Home insurance or rental insurance

Asset declarations: lender aims to guarantee that the client can repay the loan, so the borrower will probably need to provide some of the following documents to show the current state of his finances:

1. Bank statements
2. Tax returns
3. Employment verification
4. Application. Now that the borrower has the necessary information, he can fill out an application online or in person.
5. Waiting for approval. Traditional banks can take several weeks to approve an application, while online lenders may even fund loans within one business day. After approval, the borrower can review the loan amount, interest, APR, monthly payment, and loan terms.
6. Receiving money

The lender can send money to its client's bank account, write a check, make a direct payment or offer cash.

How to repay a loan debt?

A borrower has several ways to repay his loan. For instance, some lenders have their own loan repayment apps with a simple interface, but it is always possible to go outright to the office or the bank branch and make a direct payment, write a check with a due date, pay by card, or cash. It is usually possible to choose the most convenient option.

There are several steps for those who want to repay a loan debt faster:

• Refinance
• Make loan payments more frequently (on a weekly basis instead of monthly payments)
• Round up loan payments

Pros and cons of a loan

There are more than five main types of loans, and each of them has its advantages and disadvantages.

Whether there is a personal loan, federal student loan, or any other type, the main drawbacks stay the same:

• It is impossible to reuse the loan funds once used, unlike what happens with a credit account.
• Generally, it is necessary to provide guarantees and a full set of documents to take out a loan.
• It is necessary to determine the loan amount needed precisely.
• The borrower acquires the responsibility of paying money that he has already used. He can face moments of uncertainty that put the payment of the loan at risk.
• Origination fees and other penalties can be relatively high.

The advantages of different types of loans are the same too:

• Loans can be originated for different purposes. Any individual can obtain loan proceeds deposited in their bank account. Funds could be invested in products, goods, property, education, renovations, new businesses, or other necessities.
• Taking out even a $500 loan may improve the borrower's credit. Even checking the credit report, called soft credit inquiry, can improve the credit score. Bank does not impact your credit score because a soft credit pull is used.
• Compared with other instruments such as credit cards or credit lines, loans usually have lower interests and higher borrowing limits.
• Some lenders may offer special features like a rate beat program to attract new clients.

Legal regulation of the loans market in the USA

The Federal Reserve is responsible for performing the US monetary policy, supervising banking institutions, and maintaining the financial system's stability.

The Federal Reserves pursue its policy via such agencies as the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) on the state level and via individual state departments on the local level.

Below there are some protective measures for borrowers:

• PROHIBITIONS ON UNFAIR, DECEPTIVE, OR ABUSIVE ACTS OR PRACTICES (UDAAPS) IN CONSUMER LENDING (also known as a Dodd-Frank Act)
• PROHIBITION ON UNSAFE AND UNSOUND BANKING PRACTICES (The Federal Deposit Insurance Act (FDI Act)
• LIMITS ON LOANS TO ONE BORROWER
• RESTRICTIONS ON LENDING TO AFFILIATES
• ANTI-TYING RULES (The Bank Holding Company Act (BHC Act)
• PROHIBITIONS ON DISCRIMINATION (The Equal Credit Opportunity Act (ECOA)
• CONSUMER LENDING DISCLOSURE OBLIGATIONS (Truth in Lending Act (TILA) and Regulation Z)

The real cost of a loan in the US

The real cost of a loan is composed of loan principal, interest, and all additional charges.

The difference between cheap and expensive loans also comes from these additional hidden charges, such as legal insurance or other expenses. It may even happen that a loan with a meager rate is quite a bit more expensive than another with a higher nominal interest rate.

Therefore, we recommend carefully examining all contract terms before signing a borrower agreement.

Things to keep in mind

Take into account the following options to determine the real cost of any loan:

• The loan amount
• The cost of fees
• The frequency of loan payments
• The loan term
• The rate charged
• The total amount to be paid to the lender

Long-term loans with lower monthly payments may be more attractive a priori. However, the total repayment (the sum of interest plus the requested principal) will be much higher because while the return of the principal is delayed, the interest cost is higher.

For example, if a person applies for a loan amount of $5,000 for three years at a monthly cost of $165, the total repayment is $6631.

Another borrower requests the same loan amount from the same lender to repay it in 5 years at a monthly cost of $ 110.52, resulting in a total cost of $7298.

This case confirms that it is better to opt for shorter-term loans because the total loan costs will be much lower.

Check the APR before taking out a loan

APR stands for annual percentage rate, and it is the loan price, including the nominal interest rate, commissions, and other expenses (opening, etc.).

To calculate the cost of your loan, take the total loan amount and divide it by the APR.

This figure will mean the total interest payment charged in a year. Many borrowers can not afford to repay their loan within a loan term of a year. However, they can take out a small loan and pay a debt in a few months, or they may choose a larger loan, such as a mortgage, with a longer loan term (like dozens of years in the case of mortgages).

Remember that the APR is a rate that includes all the loan expenses. And that is calculated on an annual basis. If the loan is for less than one year, the APR can be very high. With equal amounts and repayment terms, the best personal loan will be the one with a lower APR.

Fees and other expenses

A lender can include any other fees and other expenses in the agreement. For example, some lenders may charge around a 2% penalty for those who repay their debt earlier than projected, calling it a prepayment penalty.