A bank loan can provide numerous benefits, but it is a risk to both you and the lender. The lender runs the risk of lending you the money but not getting fully repaid. And as for your own personal financial health, you can lose money or even your house. This is why lenders employ careful underwriting standards to minimize the risk for both parties.
A bank loan adds extra debt. Depending on the size of the loan, this can be several thousand dollars per month. Even if you carefully examine your budget, it can still be a burden. Not only that, but there is always a possibility that your financial situation can change suddenly and drastically due to illness or job loss. A payment that was manageable one month can become impossible to make the next. This is why you should make sure new loan payments don't take you to the brink of your financial capacity.
If you end up in a situation where you begin to miss payments, it will negatively affect your credit score. If you are a few days late here or there, it won’t matter. Once a payment is more than 30 days late, however, the bank reports the delinquency to the credit bureaus. Multiple missed payments of 30, 60 or 90 days all add up -- to ruin your credit. Once your credit score has declined, it can take years to repair. This will inhibit your ability to obtain financing for the forseeable future.
If you secure your loan with an asset, you run the risk of losing that asset if the loan goes bad. Once you are 90 days past due, the bank will typically send you a default letter demanding immediate repayment of the loan. If you can’t repay, the bank will initiate foreclosure proceedings. This is a legal process in which the bank takes possession of the asset, typically real estate. It will then sell the asset at an auction and use the money to recoup its loss. You end up losing your house, car, account or whatever other collateral you pledged to secure the loan.
Risks for the Bank
You are not the only party with risk when it comes to a bank loan. The bank is at risk by lending you the money. Due to the legal cost of recouping loan loss, banks rarely recover the entire amount lent to a defaulted borrower. Too many of these bad loans cut into a bank’s profits and can ultimately hurt its business. If multiple banks carry numerous bad loans, it can negatively affect the market, driving rates up. This can have a negative effect on the economy as a whole.
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