Transcript: CIBC US Financial Toolbox podcast, Episode 2 — What to Expect When Applying for a Personal Loan
>> Narrator: Welcome to Financial Toolbox, a podcast series sponsored by CIBC Bank USA that understands that financial wellness is not innate, it's learned. Whether you're a member of the next generation wanting to start your financial journey out strong or you're a lifelong learner looking to improve your financial standing moving forward, our team of experts are here to equip you with the information you need to help make your ambitions a reality. And now for this week's episode.
>> Steven Yi: Hello and welcome to Financial Toolbox. My name is Steven Yi, capital advisor for CIBC US. I'm pleased to be your host for today. For this episode, we'll discuss consideration when thinking about applying for a personal loan, what to expect during the application process, and ultimately once the loan is placed, then what? Joining me today to discuss further is Mark Schmidt, private banker here at CIBC. Mark, welcome and thank you for joining us today.
>> Mark Schmidt: Thank you, Steven. Appreciate it. Good to be here.
>> Steven Yi: So, Mark, you worked as a relationship manager and as a credit specialist in lending for many years. What are some important things to consider before applying for a loan?
>> Mark Schmidt: That's a good question, Steven. I think first and foremost, getting a loan should really never be taken lightly. It's a big decision that people should definitely think about. I think one of the key questions is, do you even really need a loan? Is there a way to wait for whatever it is that you're purchasing, acquiring, and pay cash for it rather than just getting a loan? So, I think that's the first step.
>> Steven Yi: So, what's the second step thereafter?
>> Mark Schmidt: Yeah, I think deciding how much you're comfortable borrowing. Something that to keep in mind is that the bank that you may go to might approve you for more than what you should really take. So you can't always just use whatever the bank is willing to approve as the number that you want to go with for a loan. For instance, I watch some of these TV shows, HGTV and whatnot, and they always have a young couple on there looking to buy a house and they'll say, oh, the bank approved me for half a million dollars, or whatever the number is, and they say, well, if that's what the bank approved me for, that's what I'll go ahead and get. And I think that's a mistake. I think people should each look at their own situation, their own budget, their own needs and so forth, and decide whether that half a million dollars is really what they should be borrowing, or maybe 400,000 is really more the number for them, regardless of what the bank may approve them for. So I guess don't just look to the bank to tell you how much you can borrow, decide for yourself based on your circumstances.
>> Steven Yi: Okay. So also, I guess they may want to think about the amount of borrowing, is that sufficient to accomplish what they need to accomplish? Maybe setting aside a little bit of incremental reserve for some unexpected costs related to whatever project or investment they want to make. But that's a very good suggestion to think about how much they need to borrow versus how much they’re going to approve to borrow. Okay. So what would be the next thing they need to focus on?
>> Mark Schmidt: Sure. I think another thing to think about is what the plan is to repay the loan. Certainly whenever you borrow money, you should always know how you're going to go ahead and get that paid back. If it's something that you think you might pay off early, be sure that there's no prepayment penalty. Sometimes, especially with mortgages, you'll see that there's a prepayment penalty if you pay it off early. So if you plan on just going and paying it off over the term of the loan, maybe that's not as much of a consideration. But if you think that you might have your income go up in the near term, either through promotions or raises, or if there's going to be a liquidity event of some sort, and you may pay it off early, make sure that there's no prepayment for doing so.
>> Steven Yi: That's an excellent point, but just one thing that I may follow up on that matter is that if a borrower is subject to a schedule amortization schedule payment plan, and if the prepayment is permitted, is it available for them to apply the prepayment and schedule order payment or inverse order payment?
>> Mark Schmidt: Yeah, I guess, so there's maybe two different types of prepayment. There's prepayment in full. In other words, you're just going to pay the entire loan off. And that's where there's usually a prepayment penalty if you completely pay the loan off. If you were to prepay a payment or two, let's say your payment is $3,000 a month and you came into a little bit of money and you wanted to put $9,000 all in one month, the way that that would typically work is that that would go to reduce the principal amount by $9,000, but it would not stop the next payments of $3,000 or the payment after that for $3,000. So your payment schedule would continue and it basically would come off of the backend, but it wouldn't relieve you from making those payments for the next three months in my example.
>> Steven Yi: Okay. What are the duration of most loans? Are they short-term in nature? Are longer-term loans available?
>> Mark Schmidt: Sure. I mean, there's a variety of what we call term or length of a loan. It largely depends on what the loan is being obtained for. In other words, for a house, if you're going to buy a house, which is a very long-term asset, that's going to typically have a much longer term on the loan, usually 30 years. If you're going to get something that's much shorter term, maybe a car is kind of a medium-term. That's usually in the five-year range. For most people, they can go up to seven years in some cases. And then, and not to lose the point that a credit card is a type of loan, it's just done through a piece of plastic that you swipe or tap, but a credit card is also a type of borrowing, and that is very short-term. And obviously you just usually pay that off each month as the bill comes in.
>> Steven Yi: Speaking of credit cards, depending on whether you're carrying a balance or not, and depending on your credit score, the cost of maintaining a loan amount that you owe in a credit card can be very pricey. And similarly, I guess, a personal loan. So can you talk to us a little bit about the cost associated with obtaining these loans?
>> Mark Schmidt: Yeah, so the cost of a loan is determined through an interest rate. And I guess just to take a step back, there's two different types of interest rates. One's good, one's bad if you're the consumer. So the interest that you earn on your deposits is obviously good, right? Because money that you're earning. So if you put money into a savings account at a bank, you're going to be paid an interest rate, and that's money that you earn. So that's a good type of interest. When you're borrowing money, you then pay an interest rate, which obviously, you want that to be as low as possible. So, two different types of interest. So it kind of depends on the context as to how you would view it, whether you want the rate to be high as in a savings rate or low as in a borrowing rate.
But that being said, there's also two different types of rates when you're borrowing. So putting aside the savings rates for a second, on the borrowing side, you have fixed rates, or you have variable or sometimes called floating rates. Now the pros and cons of each with a fixed rate, the pro of having your rate fixed right at the beginning of the loan is that you obviously know what your interest costs are going to be. So that rate is never going to change throughout the entire term, regardless of whether it's 3, 5, 30 years, whatever the case may be, that interest rate is always going to be known and is going to stay the same. So that makes it easier for you to budget, so you know exactly what the cost is going to be each month, and you can budget easier. The con to that, or what doesn't work out so well with a fixed rate, is that it's generally higher to start with than a variable or a floating rate would be.
So if you're comparing the two, you'll see a fixed rate's going to be slightly higher, but for the benefits that we just talked about, you might want to still go that route. The variable is going to obviously change or vary from time to time, depending on what the market interest rates are doing. So the downside of having a fixed rate is if rates do end up going down, which they have been over recently, then you don't get the benefit of that lower rate. You're still stuck at the fixed rate that you initially agreed to. The good thing is that you can oftentimes refinance into a new loan at the new lower rate. For example, if you were to get a fixed rate mortgage, let's say, at say 7%, and then rates go down to 6%, you can then refinance that mortgage into a new loan at the current 6% rate. Now there'll be some costs to do that and some time and paperwork and that sort of thing, but oftentimes the savings and interest cost is worth it.
>> Steven Yi: Well, thank you. I guess it also depends on the individual borrower’s sort of level of risk tolerance. If someone is conservative, they want to know exactly how much they have to pay each month for a set period of time under the loan. Fixed rate might be the kind of structure that will work well for them. And also, if they believe that rates are attractive right now versus what it may be in a year or two or three or four, five years from now, they may want to just take advantage of locking in the fixed rate when the rates they believe are more attractive than it would be going forward.
>> Mark Schmidt: That's a great point, just to carry that forward, a variable rate, because it's floating, it could go up or down. And sometimes, as I said, a fixed rate is generally going to start higher than the variable rate would. So, if you're looking to get a loan and you're comparing the two, it might be easy to go for the lower rate just because it's a little bit cheaper at the get-go. But if rates do go up, you're subject to those higher rates, and so you have to factor that into your thought process and make sure that you've got enough buffer to handle higher interest rates if they should happen.
>> Steven Yi: Let's move on to the next subtopic in this process. Lenders often look for collateral when making a loan. So mortgages and car loans are examples of where they are secured by a borrower's asset. What do you say to individuals looking to borrow and maybe they may have some flexibility as to how they want to go about proposing their loan?
>> Mark Schmidt: Yeah, I mean there's secured lending and then there's unsecured lending. So from the bank's perspective, they like to have collateral. Collateral is something that the person who's getting the loan can put up or pledge in support of the loan, and it's something that the bank can then look to sell. If things don't go well and you stop making payments on that loan, the bank can then get that collateral, sell it and get repaid that way. If you're getting a car loan, the car would serve as the collateral for that loan. If you're buying a house, the house would serve as the collateral for the mortgage. And so those are all collateralized loans. And as a collateralized loan, since there's more security, more safety, less risk for the bank, the interest rate that's being charged on that collateralized, secured loan is going to be less than what it would be on an unsecured loan. The classic example of an unsecured loan, as I mentioned, is a credit card. When people go get a credit card, they aren't putting up their car, their house, or other assets. It's just an unsecured line of credit that they have with the bank. And so, in that case, if you default on your credit card, there is no collateral for the bank to go after, which is part of the reason that the interest rate on credit cards is so high.
>> Steven Yi: So risk aversion, as they look at borrowing requests, they tend to price secure loans better with lower costs to the borrower than they would otherwise do for what would be considered an unsecured loan. So, moving on, once someone has decided to move forward, what should they expect from the process, from the bank?
>> Mark Schmidt: Yeah, I mean, lenders, when they're looking at a prospective borrower, they like to see stable employment, long-term residency, and a history of paying debts on time. So those are three of the primary things that a bank is going to look for to help them evaluate that. They're going to ask for a couple things. One, they're going to pull a credit report on the borrower, and the reporting agencies have a history of each person's payment history on things like credit cards, car loans, mortgages, and it'll say, were those payments made on time? Did they use the debt appropriately or not? And they'll take all that information, put it into an algorithm and come up with a credit score, which people are generally familiar with. And the higher the score, the better the risk is. As far as a bank is concerned. A low score indicates that somebody is not using credit the way that they're supposed to. They're late with their payments, maybe they didn't pay at all and it had to go to collections, things like that.
Everybody should know what their score is, especially if they're going to be looking for a loan anytime in the near future. So one good practice for people to have is to go and pull their own credit report and see what is being reported on them to other banks. So each person can go to annualcreditreport.com and get one free credit report each year. Do not go to creditreport.com or I think it's freecreditreport.com. There's some other for-profit companies that are out there that kind of mimic that email address, but annualcreditreport.com is the one that's provided for free. So each person could go there and see what their credit score is and what their history looks like, and if there's anything wrong on there, certainly review it. And if there's something that's being misrepresented, then you have an opportunity to go fix that and get that corrected.
>> Steven Yi: Okay. Well, just staying on that point, so if you see something that shouldn't be there, would you be going to the credit bureau or would you be going to the underlying source? For example, if your local bank had you down for a past due payment, if it was done in error, what should I be thinking about doing first? Do I go to the local bank first to get that corrected?
>> Mark Schmidt: Yes. Yeah, you would go to the institution, bank, that is reporting. The agencies, Equifax and TransUnion and so forth, they're just a reporting agency. They just take the information from the financial institutions, put it together in a nice format and then report on it. So they don't really do anything as far as correcting it. You would have to go to whichever institution is misreporting the information in order to get that corrected.
>> Steven Yi: That's very important that you not only check for accuracy and completeness, but also following up as needed should there be any inaccurate information, so that you can get that corrected to have the right credit score.
>> Mark Schmidt: Or fraud. Right. You want to look for stuff that you don't have any clue what it is. It's one thing if, oh, I know I have a loan with so-and-so, and it looks like that's not being reported correctly. It's another thing altogether to have an item on there that you completely do not recognize or multiple items you don't recognize, which could indicate that your identity has been stolen, in which case you should follow steps to get that rectified and put a freeze on your credit and so forth.
>> Steven Yi: Yeah. Well, that's an excellent point. So, if you see borrowing from an institution that you've never heard of, for a nature that you just don't know anything about, that could be an indication that something fraudulent has taken place on your account. So that's an excellent point. So as part of the lender's review of the borrower's applications, what kind of information would the lender request from the borrower to sort of continue with their assessment of the borrower's creditworthiness?
>> Mark Schmidt: As we said, a lender's going to look for stable employment, long-term residency and the history of paying debts, so that the credit report helps with the history of paying debts. But as far as stable employments, a bank is going to want to have income and asset verification, which will be accomplished through collecting a copy of your pay stub, for example, copy of a tax return, bank statements, what's called a personal financial statement, which is just your personal balance sheet. What assets do you have, what liabilities do you have, what's your net worth? They're going to want some employment verification, W2, things of that nature in order to verify income and your assets. And then carrying that forward a little bit too, assuming that it's a secured loan, and I guess I'm thinking more of a mortgage in this example, but there'd be an appraisal that would need to be ordered on the house to see that the value is what we think it is. So if you're buying a house, you're going to want to make sure that the appraised value comes in around the same as the purchase price.
And if it's a car, I guess the same thing, you'd still want to value that asset to make sure that it is supportive of the loan. And then finally, there's what's known in the banking industry as Know Your Customer or KYC is the term that you sometimes hear. That's all driver's license copy, address verification. Maybe it's a copy of a utility to make sure that you actually live at a certain address and things of that nature that we need to collect in order to make sure that we are dealing with the person that we think we are dealing with.
>> Steven Yi: Yes. So just going back to appraisal and getting home mortgages as an example. So it is important to know that the lender will not lend a hundred percent of the value of your pledge collateral for the loan. So taking a mortgage loan as an example, if you put up your house as collateral for a mortgage from a lender and get your house appraised and whatever the appraised value is, the lender's loan amount would not be a hundred percent of that appraised value. It'll be some percentage of that. It could be 70, 80, 90% depending on the strength of the obligor and the comfort of the lender. So, it's important that you are prepared to have a meaningful portion of the appraised value contributed as your down payment so that the loan amount is a subset of the total value of your house that's been appraised in connection with the loan. Once the loan is in place, then what? Can you just walk us through that?
>> Mark Schmidt: Yeah, I mean, this one's pretty simple. Once you get a loan, your sole responsibility is to make the payments on time. So it's pretty much that easy. So just make sure that they're on time, and by doing that, that's going to help build or maintain a good credit score. And why that's important is the good credit helps with getting a job, perhaps. Employers will typically run credit reports to see what's this potential employee, how do they handle their personal affairs? So they'll generally pull a credit report before hiring somebody. It'll help with renting an apartment because landlords will pull a credit report for the same reason. They want to make sure that their rent's going to get paid on time. It'll help you get the best interest rates on either a car loan or a mortgage. So it's important to maintain and build a strong credit score, and paying your loan on time or even early for that matter, is the best way to do that.
>> Steven Yi: Yeah, it's important not only to get good terms for your loan, but once you have the loan in place, that you follow up as required on each loan arrangement, that you make the payment on time and take other actions as you are expected to do on the loan agreement, so that you continue to maintain a good payment history and develop a strong credit score, as they get looked at by your potential employers or your landlords or what have you, as applicable. So this has been great. Is there any other advice that might be helpful to our listeners?
>> Mark Schmidt: I think the only other thing I might comment on is whenever you're being asked to co-sign or guarantee the loan for either a friend or a family member, you should really think long and hard before doing that. Understand that if you were to co-sign or guarantee a loan, say for a friend, you are on that loan, you are on the hook for the entire amount of the loan that's being taken. So it may impact your ability to get other loans. It may impact your credit score because as a co-signer or guarantee of that loan, it's going to start being reported to the credit agencies on your credit report. So if you then turn around and go try to buy a house and want to get a mortgage, the loan that you've co-signed for will be showing up there and may affect your ability or the amount that you can qualify for on that mortgage.
So much like getting a loan yourself, you should not take that decision lightly, and you should really think about whether you need to get that loan when you're co-signing or guaranteeing for somebody else. You should really think very strong and hard before doing anything like that. It can also damage the relationship because if you co-sign for even a family member or a friend, and they don't make the payments and you now have bad credit because of them, that's not going to help be endearing to you with that friend or that family member. So anyway, I guess that's the only thing I wanted to mention as well, that you should really think long and hard and I generally would advise against doing it if you can avoid it.
>> Steven Yi: That's very good advice, important for all of us to be aware. It's just like you borrowing that loan yourself, right? Even though you are working as a guarantor.
>> Mark Schmidt: Exactly.
>> Steven Yi: So that's very important advice for all of us to be aware of and be mindful of. So Mark, thank you. Very enlightening hearing your perspective. And to our listeners, thank you all for joining us on our podcast with a focus on the many considerations involved when applying for a personal loan. If you have any additional questions, please reach out to your relationship manager at CIBC to assist. You can also check us out at cibc.com/us or across several social media platforms by searching for CIBC_US. Thanks for listening. We look forward to catching up again soon.
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