Do you need to borrow money? What could be old hat to some people can be a new and scary experience for others.
If you’ve never used a line of credit or personal loan before, you might not know how borrowing works, and that’s okay. Everyone has to start somewhere. This article is here to help you navigate the big, scary world of borrowing, so you can make a more informed choice with your money.
1. There Are Many Different Loans
When people say they need to borrow money, they aren’t all talking about the same thing.
Many different loans are available, including cash advances, lines of credit, installment loans, title loans, student loans, debt consolidation, and mortgages. Each one has a unique purpose in your finances.
Generally speaking, you can split personal loans into the following broad categories:
- Fixed vs Variable: This category refers to the way lenders apply your interest — either by a fixed or variable rate. Variable means your interest may rise or fall according to the market. It’s an option most popular with mortgages or student loans.
- Secured vs Unsecured: Lenders assess the security of granting you a loan in many ways. If you opt for a secured loan or line of credit, you must provide collateral that your lender may take as payment should you fail to repay what you owe. Unsecured loans don’t require collateral and are determined by your financial profile.
- Term vs Revolving: A term loan grants you a predetermined amount you must pay back according to a specified date. Once you do, the account closes permanently. Revolving accounts (which include lines of credit) grant you a limit from which you can withdraw. It remains open after you pay off what you use, so you can draw against it on a recurring basis.
2. Interest is an Important Feature
Regardless of what kind of loan you borrow, you will have to pay interest. Interest is considered the cost of borrowing. It is the amount lenders charge on top of your principal.
Since interest adds to what you owe, you need to know your interest rate. You should also look at your annual percentage rate (APR). Your APR includes interest and other finance charges that your lender may apply to your account. As a result, it gives you a more holistic look at the cost of your loan or line of credit.
3. Your Credit Score May Affect Your Options
Before you borrow, you should get used to the idea of credit. Your credit reflects your borrowing history, and legitimate lenders will always check this before they grant you funds. Some consider it amongst other financial information to see if you qualify. Others may also use it to set your interest rate in what’s called risk-based pricing.
If this is your first time borrowing, you might not have any credit for your lender to review. This makes you credit invisible.
Some lenders may be wary of lending you money without knowing how you have handled loans in the past, but not all lenders share their hesitation. Some may be willing to give the invisible a chance, but you may have to pay higher fees to offset your risk.
As you borrow more, you’ll start to build your credit file. Positive entries (i.e., paying bills on time and keeping your line of credit usage low) may help you qualify for more affordable options.
The Takeaway:
A lot of things are involved in borrowing, and they can affect how expensive your loan is and how quickly you have to pay it back. Understanding these factors can help you find something more affordable.