How to be prepared if you decide to apply for credit
In the mid 1990’s I wrote a manual as a technical communication course project based upon my experience as an Account Manager for a major Canadian bank.
The information does not in any way divulge or betray confidentiality with my former clients. I cannot share their stories, but I can share the lessons.
The Canadian and American banking systems are different. However, there is information about credit management that may help you to be better prepared in this area.
This thread is about applying for credit and how to do it sensibly.
We need to begin before you make an appointment to obtain a loan.
Why do you want the loan?
Do you have your eye on a shiny new __________(fill in the blank)?
Are you getting married and have decided to start off your married life indebted? Do you want a little extra for a nice honeymoon?
Or is it for the worst reason of all, do you want a loan to pay off a pile of other debt?
The reason behind why you want the loan may be the reason why obtaining a loan is a bad decision.
Traditionally, people took on debt to buy a home through a mortgage. Later, car loans became an accepted reason for debt. Now, people take loans for everything.
A home is generally considered an appreciable asset meaning an asset who value will increase over time. A vehicle is a depreciable asset meaning it will lose “book” value every year. There are exceptions for both examples but they are not applicable in this thread.
Both the home and the vehicle become the chattel or security for the mortgage or loan. If you default, you lose the home or the vehicle.
There are loans which do not build assets. These are “band-aid” loans that cover one of two consumer problems: no savings or overspending.
People who take these kind of loans will either pledge their existing assets to get the loan. In their desperation to make the deal, they will pledge assets which are far more than the value of the loan. Now they are in a situation where if they default, they lose assets.
The question is why were they so desperate for a loan in the first place? If preparation prevents panic, then could we not also consider that savings prevent making bad financial deals?
We can take that a step further and consider that sensible spending would also help prevent making unwise financial deals.
Unsecured credit, such as credit card debt usually involves spending and having nothing to show for it. There are exceptions where people use their credit card to buy an item with asset value, but they are not the rule.
Credit cards can be considered an extension of income by some consumers and that is a very dangerous way to think of credit. Credit is never an extension of your income. You shouldn’t need a credit card to make monthly expenses.
A credit card balance should be paid in full per the terms of the contract each and every month. If you do that, you build a good credit bureau rating which will make a difference when you do buy a house. People with good credit bureaus get better deals because they are considered a good credit risk.
If you are taking a consolidation loan to pay off other debt, understand that this type of loan is both a green and red light to a bank. On the “go” side, they will give you that type of loan because they can charge more interest and get you to pledge assets right down to your household items.
On the “stop’ side, they will drop you like a hot rock if you walk in and try once too often to get another consolidation loan. On your credit bureau, these types of loans are considered a “whoops” the first time. You may drop points the first time. If you repeatedly need consolidations loans to cover overspending, then your credit bureau is adversely affected.
A consolidation loan is a rescue loan. Think of it as a non-swimmer who repeatedly goes into water over their head. The first time they need to be rescued, it’s forgiven. Imagine what lenders think the second, third, or fourth time. It can also be a red flag that someone has an addiction problem such as gambling.
There is a sensible way to prepare for credit.
First make sure why you want the loan is for a good reason and not the result of an impulse decision to buy something.
Next, if your reason is sound, then determine what you can afford for a payment each month. That’s right. I did say it: you determine what you can afford each month and how long you want to be indebted or the term of the loan.
The banks generally use a debt service ratio which means they say you can afford x% of your income each month for a mortgage or other debt.
They take a basic personal financial statement. What do you earn? They list and total your basic expenses: rent/mortgage, utilities, debt, insurance, etc.
The difference between the two is what they consider to be your disposable income.
The bank doesn’t live with you. They are using a formula approach which isn’t real life.
You need to determine what you can consistently and comfortably live with each month. In order to do that you need to track every cent of your disposable income that you spend each month. There are two steps to take to do this each done at the same time.
Take the amount that you currently think you can afford to repay a loan and set it aside in a separate savings account. Do this every month for 6 months minimum. Treat is as if it were a loan payment. Make notes of any times or months when it was hard to do. This is a test of what you can really live with each month.
At the end of that 6 month minimum, you should have a very good idea of whether x amount of money will be comfortable for you to repay before you commit to the actual loan.
The bonus is that you also have self-insured a minimum of 6 months of loan payments in case of crisis or income interruption.
You also have given yourself time to think and consider the expenditure and maybe even shop around for a better deal.
At the same time, set up a simple tracking method for how you spend your income.
Start with fixed expenses such as rent or mortgage, utilities, insurance, etc. and set them up on a budget sheet. Include savings set aside each month over and above the amount in the test loan amount. Be certain of your expenses and verify them if necessary.
On another sheet write down your disposable income expenses.
Write down the date, amount, what was purchased and how you paid for the item. For example:
If you use multiple accounts or credit card, list them on separate pages.
Jan 1 $126.40 Joe’s Hardware Garden supplies
You can also use the information to track a return, credit memo or R&M (repairs and maintenance) for vehicle and home expenses.
The amount saved for the “test” loan is also good for your credit bureau.
If there is interest, let me know and I will gladly go through some of the other areas in a future thread(s).