Knowing about different aspects of finance is important for everyone. Loans and mortgages are two areas in particular that are crucial to not only understand on their own but the influence that they have on other areas of finance. They are an integral part of modern life, whether it is getting a loan for further study or purchasing your first house, so it’s important to understand how they work.
1. What Loans And Mortgages Are
A loan is an agreement where one party, typically a bank or another financial institution, lends money to another party. A mortgage is when someone borrows money so they can buy a home. The lender will take your house as security for the loan in case you cannot pay it back, meaning that if you default on your loan they can repossess your house and sell it to recoup their money. Loans and mortgages are typically repaid with interest, meaning that if you borrow $100,000 at an annual interest rate of 5%, you will owe $105,000 once a year has passed.
When it comes to mortgages, you can get pre-approved for one. What that means is that a bank or other financial institution will vouch for you, saying that you are creditworthy and therefore eligible to take out a mortgage. You can read more here if you’d like to know about the benefits of getting pre-approved for a mortgage, as well as how to apply for that. As for loans, there are a number of different types. You can get ones that you pay back over time, called installment loans.
Or, if you need to borrow money for certain expenses, like buying a new car or paying off medical bills, you can use an unsecured loan, where the lender doesn’t take security against your loan in case it isn’t paid back. Looking into different kinds of loans can help you make a decision about which one works best for your circumstances.
2. Debt To Income Ratio
You may have heard of this ratio in the news when talking about mortgages since it’s important for whether or not you are approved for a loan. It is calculated by dividing your debt level by your income level. To give an example, if your monthly income is $5,000 and you owe $2,500 on your credit cards every month, then your debt to income ratio is 40%. Often if this number is too high or low for the bank to be comfortable with it will mean that you are not approved for a loan.
The higher the percentage, the more likely you won’t get approved for a mortgage. This calculation includes any loans and debts that you have so it’s important to take this into account when considering how much income you should be earning to get approved for a loan. In other words, your income should be higher than your debt so that it is lower or equal to your debt to income ratio.
3. Income And The Amount You Can Borrow
While your income (and debt) are important factors in whether you can get a mortgage at all, how much you earn helps to determine how much you can borrow. This calculation is a little more complicated since it takes into account your monthly expenses versus your monthly income, as well as whether or not you have other debts that you need to repay. Each bank comes up with its own calculation for this so it’s important to speak with them about what works best for you.
If we suppose that you don’t have any outstanding debts, then the situation is a bit more clear. When you earn more money your ability to borrow increases, up to a certain income where you can take out the full loan. A lot of banks and other lenders will have clear conditions you have to meet when applying for a certain amount, as well as for getting approved for a mortgage. You can research different banks to see how much you can borrow when based on your income, and then apply based on that. In general, the more money you make, the larger the loan amount you will qualify for.
However, there are also some lenders who will have a minimum income requirement. Whenever you’re taking out a loan, but in this situation even more so, it’s important to read the fine print, and take a good look if that’s the best thing for your finances at the moment.
Something to keep in mind is that loans are generally paid back in interest while mortgages have to be paid in full so it’s important to know which will work best in your situation. Reaching out to experts that can help you make sense of your finances is always recommended since it’s important to get a full picture of your assets and debts. With that being said, there are a number of different loans and mortgages out there so whether you’re looking for a small loan or want to buy a big house, knowing about the different kinds and what can work best in your situation is important.