Thursday, March 28, 2019
A short discussion on Loans
What is loan?
Hey guys, I am Sagar Panta and welcome to our blog. I am very excited about today's topic. Today we are going to have a short discussion over loan. So, lets start.
Meet Lucy. Lucy has been working at Corporate Co. for the
past three years. Since her very first day on the job, Lucy has seen her
colleagues refinance students loans (Zoe), purchase cars (Joan), and even buy
houses (Emily). Lucy wants to be like them, there’s just one problem: all these
activities require loans, and Lucy just doesn’t feel confident handling them.
What should she to do? Well, her first step is simple: understand how loans
work.
On their most basic level, loans are simply borrowed money. Lenders, such
as banks, can give borrowers, such as Lucy, a fixed amount of money called
principal, like $10,000 to buy a car. However, the bank isn’t giving Lucy this
money for free. In addition to paying back her principal, they’ll require Lucy
to pay a certain amount of money each month, called interest, just for using
their money. In addition, if her loan is secured, as many are due to their more
attractive interest and approval rates, the bank can seize actually the asset,
in this case her car, if she fails to repay. So how is this interest calculated
exactly? Let’s explain through an example. Let’s say Lucy’s $10,000 car loan
comes with a 5% annual interest rate. Divide that 5% by 12 months, and you get
roughly 0.4%, the monthly interest rate. That’s means Lucy owes the bank 0.4%
of her outstanding principal each month in interest.
While this seems
reasonable enough, interest rates come with three more complications:
1) Not
all interest rates are fixed. Some, called variable interest rates, can change over
time, often quite dramatically. Because of this, they can be quite risky,
especially on long-term loans.
2) The interest rate of a loan is not the same
thing as its APR. APR includes both the interest rate, either fixed or
variable, and the fees. Thus, when comparing loans to see which is cheaper,
Lucy should always use APR, not the interest rate.
3) APRs are also highly
dependent on your credit score, as the lower your score, the higher your APR.
For more details on this, be sure check out our next video “Credit Scores and
Reports 101”. So that’s interest rates.
But unfortunately, they aren't Lucy’s
only concern. She also must pay back a certain amount of her principal each
month. This payment, combined with interest, makes up Lucy’s total loan payment,
which is the money you pay the bank each month. Should Lucy want to calculate
this number herself, all she’ll need is an online calculator, like ours, and
three numbers: the amount of money borrowed, the interest rate, and the length
of the loan, also known as its term. This term is a critical number, especially
when choosing a loan. That’s because, in general, the shorter the term of the
loan, the greater your monthly loan payment. This should make sense. After all,
the less time you give yourself to repay the loan, the more you'll have to pay
each month to compensate. And while this may seem bad, shorter term loans can
actually be great, for two reasons.
1) They come with inherently lower
interest rates.
2) Because their monthly payments are much larger, the
borrower is forced to pay down the principal much faster, which ultimately
means less interest charged over the life of the loan.
This fact is so
important that we’ll repeat it. The shorter you can make your loan, either
through extra-debt repayments or a shorter term, the less interest you’ll pay
in the long-run. Hopefully you and Lucy now better understand how loans work.
Be sure to watch our next video, which covers everything you need to know about
credit scores, and be sure to check out our website, where you can find more
educational material, your free credit score, and great loan recommendations.
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But beware! Don't charmed by such attractive offers, think twice about borrowing a loan before you go ahead with this and honestly realize, do you really need a loan? Is it inevitable? Is this loan for frivolous, like a holiday? Or for something real serious an urgent need, Can you borrow money by a more traditional way,
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