If you’re beginning to venture down the road to independence, chances are high you’ll have to take out a loan at some point. Did you go to college? You probably have student loans! Further down the road, you’ll encounter car loans and home mortgages at some point too. But, don’t fear. Loans don’t have to be scary. They’re just loans and they’re easy to understand when you break them down to their basic principles. Whichever loan you choose will be easy to payback if you do your homework.
INTEREST RATES
This is how lenders make their money. There are two types of interest rates: fixed rates and variable, or adjustable, rates. They’re called this because they change (yes, kind of like an adjustable hat).
- Fixed rates — Fixed rates never change. If your fixed interest is at 5%, it will remain at 5% for the duration of the loan. These loans are preferable because you’ll likely know what you’re getting into from day one and there are no surprises like waking up to find your cat using your TV as scratching post. When taking out a student loan, or any major loan, look for low fixed rate loans. Popular student loan programs like Stafford and Perkins have low-interest rates, and the government pays the interest on subsidized Stafford loans and Perkins loans while you’re in school.
- Variable rates — Variable rates change over time and are based on a standard market rate. These can be enticing because the initial interest rates can be very low. Keep in mind that they will fluctuate and as a result, your payments will vary. Variable rates may be presented to you at a smaller percentage and then rise over time. In general, keep an eye out for predatory loans and move on from them quickly like a bad wine.1
SECURITY COMPONENT
Loans are considered secured or unsecured. One requires collateral before you borrow. The other does not.
- Secured loans — A secured loan means you have guaranteed that your lender will be repaid no matter what. This usually means you’ve given your lender permission to take specific assets of yours if you default or stop paying. The lender can seize any collateral offered in the loan agreement to recoup their investment. Guarantees like this allow lenders to charge low-interest rates.
- Unsecured loans — Unsecured loans, for the most part, have higher interest rates than secured loans. Often, the lender requires that an additional person co-signs for unsecured loans, or vows to repay the loan if the borrower cannot (time to call Mom and Dad). Luckily, student loans are collateral-free while having low-interest rates.2
LOAN TERMS
The term of a loan is the length of time the borrower has in which to pay the loan back. Typically, longer-term loans consist of higher interest rates. Remember this best practice: loans typically can be paid back before they are due without a penalty (although some loans may have a pre-payment penalty). That’s right, Ace! So, if you pay a little more back than is required every month you are winning because you’re saving money on interest.
Common reasons to take out a personal loan include:
- Consolidating debt
- Paying off credit cards
- Covering medical bills
- Saving to renovate a home or apartment
- Buying a car
Being an adult sometimes requires taking out a loan to get ahead. It happens when you’re too old to ask your parents for everything you need. It’s also empowering to make a responsible choice. Avoid the pitfalls of accepting the first loan that’s offered to you. Shopping around is essential and pay attention to the fine print. Don’t overlook any terms and avoid borrowing more than you can afford.
MORTGAGES
When you break down a loan and take a good look at it you’ll be able to make an informed decision. This is a great skill to instill in yourself as you climb the ladder of life and begin to weigh larger purchases, like buying a home.
When you’re looking to buy a home, you’re going to need a mortgage. Mortgage rates are formulated with the same basic tenets outlined above. However, there are great tools at your disposal to find one. Use this Mortgage Calculator to determine the best fit for you within your budget.