How Loans Impact Your Tap Eligibility

Taking out a loan can have a significant impact on your finances and life, and it's important to understand the risks and benefits before making a decision. Loans can be a helpful tool in certain situations, such as consolidating debt or making necessary home repairs, but they can also come with high interest rates and negative consequences for your credit score. One example is a TSP loan, which allows individuals to borrow from their retirement savings, but this can lead to having less money in your retirement account and potential tax implications. Similarly, home equity loans can provide access to funds but put your home at risk if you're unable to make payments. Understanding the specifics of different loan types and their potential consequences is crucial before making any financial decisions.

TSP loans: pros and cons

TSP loans are a type of loan that allows federal employees or uniformed service members to borrow from their Thrift Savings Plan. They are often considered a logical solution for eligible borrowers who need extra cash to finance a large or unexpected expense.

Pros

TSP loans have several advantages over other types of loans. Firstly, they have a low-interest rate, typically less than two percent, which is significantly lower than most personal loans that usually range from 2.49% to 35.99%. This means that borrowers can save money on interest payments compared to other loan options. Additionally, there are no credit checks required for TSP loans, and the qualification process is generally easy for eligible individuals. The repayment process is also convenient, as it can be set up to be deducted directly from the borrower's paycheck. Furthermore, there are no prepayment penalties or fees, so borrowers can pay off the loan early if they choose to.

Cons

One of the main disadvantages of TSP loans is the opportunity cost associated with them. By borrowing from your retirement savings, you sacrifice potential earnings and compound interest that your investments could have generated over time. Additionally, TSP loans do not help build or improve your credit score, as payments are not reported to credit bureaus. Another important consideration is that TSP loans are only available while you are employed by the government. If you leave your federal job before repaying the loan, you have only 90 days to repay the outstanding balance; otherwise, it is reported to the IRS as income, which can result in unexpected tax liabilities.

In conclusion, while TSP loans offer convenient access to funds with low-interest rates and easy qualification, they also come with the opportunity cost of sacrificing potential investment returns and have specific limitations and risks associated with employment status. It is essential to carefully consider both the pros and cons before deciding to take out a TSP loan.

Home equity loans: risks and rewards

Home equity loans can be a great way to access cash, but they come with risks. A home equity loan is a type of second mortgage that allows you to borrow a fixed amount of money based on the size of your equity or outright ownership stake in your home. The loan is repaid monthly over a set period, which can be as long as 30 years.

Risks

Home equity loans are a type of secured debt, with your home serving as collateral. This means that if you default on the loan, the lender could foreclose on your home. As such, it's important to only take out a home equity loan if you're confident you can handle the payments and have a plan for the funds that will improve your property or net worth. Additionally, if there is a significant drop in the local residential real estate market, the value of your home might decline, leaving you "underwater," where your home-backed loan balances exceed the property's value. This could make it hard to sell your home.

Rewards

Home equity loans typically offer lower interest rates compared to personal loans or credit cards, making the monthly payments more manageable. The extended repayment periods of up to 30 years also contribute to more manageable payments. Furthermore, home equity loans can provide access to larger sums of money compared to credit cards or personal loans. The funds from a home equity loan can be used for various purposes, such as home improvements, consolidating debt, or covering educational or medical expenses.

Personal loans and credit scores

Applying for a personal loan can affect your credit score in a similar way to applying for a credit card. The application triggers a credit check, known as a hard inquiry, which causes a small, temporary decline in your credit score. If your application is approved and you receive the loan, your credit score could drop by a few more points as the new credit line decreases the overall average age of your accounts.

However, a personal loan can also help your credit score if managed responsibly. For example, making regular, on-time payments will help improve your credit score over time. Every timely payment adds to your positive payment history and helps promote credit score improvement. Payment history is the factor with the greatest influence on credit scores, accounting for about 35% of your FICO® Score.

Personal loans can also help improve your credit mix, which accounts for about 10% of your FICO® Score. If a new personal loan increases the number and variety of active credit accounts in your credit reports, it could enhance your credit mix and lead to credit score improvement.

Additionally, using a personal loan for debt consolidation, specifically applying funds borrowed at a relatively low interest rate to pay down higher-interest credit card debt, could help your credit score by reducing your credit utilization ratio. Your credit utilization rate is responsible for about 30% of your FICO® Score, and utilization rates greater than about 30% tend to do significant damage to your scores.

The exact effect a personal loan has on your credit will depend on how you use it and how diligent you are at repaying it.

Loan applications and credit checks

Credit checks are divided into two types: soft and hard inquiries. Soft inquiries, or soft pulls, occur when someone checks your credit for a non-lending reason or without your permission. These can include background checks, such as an employer checking your credit before hiring you or a credit card issuer checking your credit to see if you qualify for certain offers. Soft inquiries do not affect your credit score.

Hard inquiries, on the other hand, are recorded when someone, typically a lender, checks your credit report in response to an application for credit. Hard inquiries can cause a small, temporary decline in your credit score, usually by less than five points for FICO Scores and five to ten points for VantageScores. Multiple hard inquiries from loan applications can further increase the negative effect on your credit score. However, this depends on the type of loan, the timing of the creditor's check, and the type of credit score. For example, FICO Scores ignore hard inquiries from auto, home, and student loans within the previous 30 days, whereas VantageScores count multiple hard inquiries within a 14-day period as a single inquiry.

It is important to note that personal loans can affect your credit score positively or negatively depending on how you manage the account. While applying for a personal loan may cause a temporary decline in your credit score, taking out a personal loan can help improve your credit score if managed responsibly. For instance, using a personal loan for debt consolidation by paying off higher-interest credit card debt with funds borrowed at a lower interest rate can be beneficial. Additionally, personal loans do not use your home as collateral, unlike home equity loans or home equity lines of credit (HELOCs), so your home is not at risk.

To summarise, while loan applications and the resulting hard inquiries can impact your credit score, the effect is usually minor and temporary. Furthermore, personal loans, if managed effectively, can positively influence your credit score and provide funds for various purposes without putting your assets at risk.

Using loans for home improvements

Taking out a loan to finance a home improvement project adds to your overall debt load. However, it can be a smart move if you're confident you can handle the payments and have a plan for the funds that will improve your property or your net worth.

Home improvement loan amounts can range from $1,000 to $100,000 or more, which gives you the flexibility to finance minor or major projects. If you don't have tappable equity or don't want to use your home as collateral, a personal loan might be a good option. Personal loans typically have fixed interest rates and monthly payments, allowing you to repay the money over a set period of years. They usually have no collateral requirements and can provide immediate funding. However, they may come with a heftier interest rate.

Home equity loans, on the other hand, use your home as collateral, which means you should approach them with additional caution. Defaulting on a home equity loan could allow your lender to foreclose on your home. However, home equity loans may offer more competitive interest rates and repayment choices.

When considering a loan, it's important to compare offers from multiple lenders to find the right loan for your project. Factors to consider include the annual percentage rate (APR), monthly payment, loan amount, and loan term. The loan term can significantly impact the total interest you pay over the life of the loan, with longer terms resulting in more interest paid.

Additionally, be aware that applying for a loan can affect your credit score. The application triggers a hard inquiry, typically causing a small, temporary decline in your credit score. If your application is approved, your credit score may drop a few more points as the new credit line decreases the overall average age of your accounts. However, if managed properly, a personal loan can help improve your credit score.

Frequently asked questions