Borrowing for Dummies

By: Cristian Molina and Matthew Winkley

Pros and Cons of Borrowing

Pros:

  • It helps with financial emergencies
  • Sometimes it helps with meeting criteria and debt for the end of the month
  • Makes expensive items possible to purchase
  • Can build positive credit history for aid in the future

Cons:

  • Can build negative credit
  • Failure to comply with loaner's instructions can lead to mortgaging necessities
  • Some lender's can have insane interest rates or are just plain mean
  • Unknown circumstances can lead to debt
  • A habit of borrowing can take place

Credit and Simple Interest

  • This is the act of borrowing with intent of paying it back at a later date. Normally simple interest, which is the fee for borrowing the money, is involved and typically has a high rate which means you have to pay back more money. The time it takes you to pay back the loan/ credit varies how much you actually have to pay interest for. The more time means more money and less time means less money.
  • The formula for interest is "Interest=Principal*Time*Rate" where the principal is the original borrowing amount, the time is how long until one pays it back and is measured in years or parts of years, and rate is a percentage.
Example:
John borrowed $5,000 and intended to pay it back in six years with an interest rate of 5%. Interest=5,000*6*.05

Interest=$1,500
To formulate the maturity value you add the interest to the principal to see how much you will pay.

John's Maturity Value=$6,500

Types of Interest

Fixed:

  • These interest rates remain constant throughout the payment cycle

Variabled:

  • The interest rates change periodically never giving the borrower insight on how much their next payment may be.

Amortization Schedule

This is a way of analyzing how much one will ultimately pay for the loan at the end of all the payments. It is a table that shows how much of each payment goes to the principal and interest and what the next payment will be. Interest usually is higher in the beginning payments because banks want their money first, and towards the end of the loan most of the payment goes towards the principal value.
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Schemes of the Bankers

Introductory APR is what many banks and loaning corporations advertise as a teaser Annual Percentage Rate. This rate only is valid for a few months before the companies raise the interest rates drastically. However, normal APR is the consistent amount of interest rates one will pay from month to month.
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The 5 C's of Credit

  1. Character- the reputation one has with his/her credit and how well they use it.
  2. Capacity- knowing what one's net income is and also having to pay other loans
  3. Capital- the ensuring that one can pay off the loan even if it means mortgaging assets
  4. Conditions- the other existing loans one may have, their background check and everything that depends on their finances.
  5. Collateral- the current possessions one has that the contractor of the loan can take away in order to fulfill the debt or payments.

20-10 Rule

Typically this is a rule to follow when pondering about taking a loan.

  • 20 stands for the maximum percentage of one's annual net income. It means one should not take out a loan for more than that amount if the payments are annually.
  • 10 stands for the maximum percentage of one's monthly net income. It means one should not take out a loan for more than that amount if the payments are monthly.

Myths about Borrowing

  • All Debt Is Bad: This is not necessarily true. Going into debt makes one aware of their finances which can lead to a better investment and management in the future.
  • Going In Debt Means You Are A Bad Person: False, this just means one did not use their money in a wise fashion and it led to their bankruptcy.
  • Loans Are A Replacement For Income: This is a terrible idea. Loans are only available to help a customer purchase a necessary item that their normal income would not allow.
  • You Cannot Borrow With No Credit History: Actually this is not true because everyone has to start off somewhere.
  • The More Credit Cards The Better: Having more credit cards is a burden because it tempts users into thinking they can afford more, but really the interest adds up over time and depletes their finances.

Tips for Borrowing

There are many hints on how to successfully borrow and they all depend on the situation, but here are a few that generally assist everyone.


  • Try to pay every payment on time because it will boost one's credit score.
  • Understand your interest rates even if it means hiring a financial adviser so one does not get cheated
  • Attempt an amortization schedule to see how much the amount will be.
  • Only borrow if it is a necessity
  • Do not borrow for menial items
  • Try to keep an ongoing budget until the last payment is due
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