Funding Solutions

Borrowing Basics: Understanding Credit and Loans

Two persons at the laptops

As an adult, there are two basic ways in which an individual can pay for goods and services:

  • Pay with cash
  • Pay with some form of credit


Paying with cash is the simplest form of buying an item. A person takes money from their wallet, or they use a debit card. The item is paid for and taken home!

Credit – The Other Option When You Don’t Have Cash

The other option is credit, which is the money you borrow to pay for things. It is usually referred to as a loan. You engage to pay back the money you borrowed plus some extra. The extra amount is part of the cost of borrowing money. Borrowing money to pay for anything is going to cost more. How much more? Depends on the type of credit that is used along with the applicable interest rate. It also costs more depending on how long it will take to pay it back.

Types of Credit

Once a person reaches adulthood and leaves home, their first taste of credit is not far away. Credit card offers will appear in the mail and stores will push customers to sign up for their store cards. It’s not just the temptation of cards. There are many other forms of credit that can be used to buy stuff, or at least be able to access cash if an individual has no cash on hand.
For example:

All these different loans with all their different reasons have their pros and cons, but one thing they do have in common is… interest.

The Maths of Interest

Lenders love to provide money to enable borrowers to buy all the things they want. Why? Because there will be an interest charged for the privilege of providing the funds required!

Consumers seem to be oblivious to the interest on a loan and can only see the low monthly repayments required, which seem very affordable. People want that new TV, those new clothes, that weekend resort holiday, but with such low monthly repayments, the debts can be paid off over time, right?

Example of non-Calculated Borrowing

Here is an example – buying an entertainment unit for cash versus credit.

Looking at the loan terms, it’s $25 a month, an amount that won’t overstretch a customer’s budget. Don’t forget the 20% interest rate. Pay only the minimum, and the balance accrues interest. Each month, 20% is added to the leftover balance, and that will make the balance more than what you started with. This will rollover the same every month until you have paid everything off.

That’s going to take 109 months, an unforgiving 9 years to pay off that Unit. Add the interest of $1,669 to the purchase price, and the total cost of the unit is $3,523. Add to that the fact that the item will be outdated technologically and will need replacement. Here is when that cycle of buying is ready to start again!

Careful Consideration When Borrowing

If the final decision is to borrow, for whatever reason, consider some aspects very carefully before handing over the credit card or signing a loan contract.

First of all, work out what the cost will be over time. Calculation too hard? There are plenty of online calculators. By looking at a credit card statement each month, the figures will be clearly shown.

Then answer this question: What is the least expense in a borrowing scenario? Compare the following:

  • interest rates
  • minimum payments
  • penalties

Now think again: Do you really need the item?

There is always the option of saving up to buy something. If the requirement is something big, like education, it might be worth taking out a loan as it will help significantly in the future.

Credit and Loans

Here are some scary figures about indebtedness. Currently, in the USA, there are $3.7 trillion in outstanding consumer credit, from the latest Federal Reserve figures. Not part of that amazing sum is the $14 trillion in mortgage-related borrowing. It seems that people do not have any problems with finding places from where they can borrow.

There are Pros and Cons to different types of loans. Many people don’t seem to understand how to make the choices that are to their advantage when applying for a loan or borrowing money.

Credit Cards

With a Credit Card, consumers are borrowing money from the card provider, albeit for a short time. There is no interest payable if the amount is paid by the due date. The trap most people fall into is when they don’t pay back the full amount and interest is charged on the continuing balance. Interest rates on Credit Cards vary from 10% to over 20% if the cardholder has a bad credit rating. The average in the USA is 16%.

PROS

  • Consumers have time to repay the money used, on some cards it’s 21 days.
  • Reward points work well for some people who bother to work the system and take advantage.
  • Some cards offer small discounts on purchases when the outstanding balance is paid consistently.
  • There is no limit to what an individual can buy within the limit of the card without making a new loan application.
  • Instant money.

CONS:

  • Missed payments result in accrued interest as well as the missed payment fee.
  • Interest keeps adding up on unpaid balances.
  • Some cards have annual fees.

WHERE TO GET THEM:
Banks, retailers, service businesses, other financial service providers, specially branded entities.

Personal Loans

An unsecured personal loan requires no collateral. No security is required such as a motor vehicle, jewelry, or home. The loan funds can be used as debt consolidation or to pay for a big expense or an unexpected one. Approval for a personal loan is based on a borrower’s credit rating and the ability to be able to repay the loan amount.

PROS:

  • A fixed amount monthly helps with personal budgeting.
  • They have a lower interest rate than a credit card.
  • A loan to consolidate debt and lower the use of Credit Cards helps improve financial stability.
  • A personal loan can be used for many different purposes.
  • It has a fast application and approval time.

CONS:

  • Rates are tied to the borrower’s credit rating. That means a consumer is subject to a range of rates from a low APR to rates above 20% or more depending on a person’s financial situation.
  • Approval is not always assured and certainly harder to get than a secured loan.

WHERE TO GET THEM:
Banks and online lenders.

Payday Loans

This loan is a high-interest loan for a short period usually required for an emergency and covers the borrower between paydays. It works simply: the borrower allows the lender to withdraw the amount borrowed, plus a fee and interest from the bank account after an agreed, fixed term. If the loan needs to be extended, which happens a lot, then there will be additional costs.
PROS:

  • No credit checks are required.
  • It’s access to quick cash.
  • For some individuals, it’s one of the few options available to borrow money.

CONS:

  • Payday loans come with high-interest rates and the APR can go to triple digits if the loan is continually extended.
  • There are some unethical lenders in this area and scams are fairly common.

WHERE TO GET THEM:
Online lenders and also traditional businesses.

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