There are plenty of good reasons to borrow money. You might be interested in financing a business, buying a house, or starting a career.
Whatever your reasoning, there are some important questions to ask before financing, and some important checklist items to mark off before moving forward. If you plan ahead and follow the right approach, you’ll be much more likely to end up financially ahead.
What to Do Before Borrowing Money
These are the most important steps to take before borrowing money:
- Check your credit score. Your credit score is a measure of your financial trustworthiness, as measured and evaluated by major financial institutions. No matter where or how you get a loan, you’ll need to know what your credit score is first. The higher your credit score, the more likely you are to qualify for a loan – and the better terms you’re going to get.
- Improve your credit score. If you notice your credit score is lower than you expected, or if it’s going to impact your ability to get financing, it’s a good idea to improve your credit score before applying for anything. You can do this by making payments consistently and on time, lowering your debts, and avoiding opening new lines of credit. It takes a long time and consistent effort, but it eventually pays off.
- Review non-financing options. Before you commit to taking out a loan, consider whether there are other options available. For example, could you save up money to make this purchase in full, without the need for financing? Could you get a lease and get lower monthly payments than if you made the purchase outright? These aren’t always realistic options, but they’re worth considering if available.
- Establish an emergency fund. If you can, try to create an emergency fund before you secure financing. It’s helpful to have a financial cushion that you can fall back on if things go south. That way, if you lose your job or if your financial situation faces a sudden change, you can continue making payments on time.
- Crunch the numbers. Spend some time crunching the numbers. How much of a loan are you looking to take out? What interest rates are you expecting? What other fees and expenses are you going to face? How much of a monthly payment will you be responsible for? How does that compare to your income? Does this fit within your budget? After gleaning these insights, you may feel more or less confident in your decision to finance.
- Contemplate the worst-case scenario. Next, think about the worst-case scenarios. What would happen if you were suddenly unable to pay this debt back? Most people consider the loans they take out with their current financial situation in mind; they have a set income and project it into the future. But what if you suddenly lost your job? What if your investments took a turn for the worse? Planning a contingency plan for a worst-case scenario may seem unnecessary, but it can help you minimize risk and ensure stable financial footing.
- Shop around. Many people go with the first loan option they can find, out of convenience or laziness. But it’s much better to shop around. Chances are, there are dozens, if not hundreds of lenders willing to extend financing to you, and all of them will have different terms, different strengths, and different weaknesses. Review these options carefully and choose a lender with the best possible terms to offer.
- Negotiate. Lots of people don’t realize this, but it’s usually possible to negotiate the terms of your loan. Sometimes, simply asking for a better rate or better terms can put you in a better position. Don’t be intimidated; just do your research in advance, come prepared with specific requests or questions, and try to get a better deal.
- Read the fine print. After talking things over with your lender and getting more information on the potential deal, make sure you take the time to read the fine print. What interest rate are you paying? What other fees and penalties are there? What will happen if you miss a payment? When will the loan be repaid fully? If you don’t understand something, ask about it or look it up. Don’t assume it’s all good.
- Plan to repay. Finally, put together a plan for how to repay the loan. Depending on your situation, you may want to pay off the loan early, minimize your monthly payments, or something in between.
Taking the Next Step
When you’ve taken the steps above and you’re ready to secure financing, there won’t be much left to do. Talk to your loan officer or financier, prepare the required documents, and formally submit your application (or fill out the remaining paperwork).