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Borrowing Money
Borrowing money can be intimidating, whether it is to purchase
a home or using your first credit card. Defining your needs and finding
the right solution can be a timely process but is worth the effort.
Below are some tips on how to better understand your borrowing options.
CHOOSING THE RIGHT LOAN AND THE RIGHT LENDER
Borrowers have lots of choices among types of loans and lenders. Choosing
wisely can save you a lot of money. Protect yourself from paying more
for credit than you need to by understanding the different types of
loans and lenders. Remember, if you borrow money that you cannot repay,
you can lose your home, your car, your savings and your investments.
Also, a court can order that your employer "garnish" your
earnings, that is, withhold some of your pay on behalf of a creditor.
For some loans, called "secure loans," you must put up "collateral"
- something you own that the lender can take if you don't repay the
loan. Cars, homes and savings and investment accounts are common types
of collateral. "Unsecured" loan, like credit cards, do not
require collateral.
The main types of loans are:
- Credit cards: An unsecured loan, credit cards are the best choice
for clothing, small appliances and other small purchases from department
stores.
- Consumer installment loans: Unsecured loans, these are used to
finance larger purchases like college tuition, vacations, home improvements
and major appliances and to consolidate debts. They usually must be
repaid over two to five years.
- Home loans (purchase, refinance and equity): Secured loans, these
are used to buy a home, obtain a new mortgage that costs less or use
some of the equity to pay for other major expenses.
Regardless of whether it's a secured or unsecured loan, lenders charge
both fees and a percentage rate of interest to earn a profit on the
money they lend. Before you apply for any type of loan, make sure you
know what fees and interest rate will be charged and all the other conditions
the lender places on your loan. Those conditions include, but are not
limited to:
- The loan term (how long you have to repay the loan amount, called
the "principal," plus the interest and fees)
- The amount and timing of payments
- What will happen if you make payments late or miss payments
- Whether you can repay the loan without penalty before the loan
term is up
A loan's interest rate is expressed as a percentage of the loan amount
and may be "fixed" or "variable/adjustable." A fixed
rate stays the same over the term or "life" of the loan. A
variable/adjustable rate may go up and result in a higher interest rate
and monthly payment. To see what different loans will cost, compare
their "annual percentage rates" (APRs), which include both
the interest rates and fees.
The amount of money you borrow is called the "principal."
When you repay a loan, you repay the principal plus all the interest
and fees that are charged. Before you take out a loan, determine how
much money you will be required to repay the lender over the life of
the loan. The difference between the principal and the total of all
your payments is the "cost" of the loan. Be sure you know
and can afford the cost of any loan before you sign a contract with
the lender.
Federally insured banks, savings and loans and credit unions are usually
the best place to shop for an affordable loan. Some have special programs
to help low-income applicants and applicants with poor or no credit
histories.
Other types of lenders also offer many kinds of loans. Just remember
that the easier it is for you to qualify, the more expensive
the loan is likely to be.
BUYING A HOME
Buying a home may seem complicated, but it's easy to find the help
you need.
- A bank or other mortgage lender will help you determine what size
mortgage loan you can afford and what special programs are available
to help you finance a home purchase.
- A real estate agent can help you find a home you like and can afford.
- A title company can organize the paperwork and make sure your loan
"closes" (the transaction is completed) as scheduled.
- A community group in your area may offer home ownership counseling
programs to help you understand the details of the home buying process
and the responsibilities of homeownership.
In most cases, you will contribute a "down payment" from
your own funds and you will finance the rest of the purchase price with
a mortgage loan. Depending on your income, assets like savings and investments,
debts, employment and credit history, you may be eligible for special
programs designed for first-time homebuyers by the government, the lender,
a non-profit organization or a community group.
Most mortgages have 15- or 30-year terms. The longer the term, the
lower the monthly payments and the higher the interest costs
will be over the life of the loan.
Mortgages have either "fixed" or "variable/adjustable"
interest rates. A fixed rate means that the interest rate
stays the same over the life of the loan. A variable/adjustable
rate means that the interest rate can change significantly
over time. If you plan to own your home for just a few years,
a variable-rate loan may be more affordable because lenders
often offer a lower interest rate and lower monthly payments
at the beginning of the loan term. If you plan to keep the
home for many years, a variable-rate loan may result in much
higher monthly payments in the future.
Mortgage lenders offer a tremendous variety of loans. Ask several
lenders for information on their loans in writing before you apply for
a loan. Compare the following:
- Annual percentage rate (APR), which includes the interest
rate and any "points" charged. A point is one
percent of the loan amount.
- Fees and estimated closing or settlement costs.
- Loan term (the number of years you will have to repay
the loan).
- Monthly payment amount, including principal, interest,
taxes, home insurance and private mortgage insurance (if
required). If the loan has a variable interest rate, ask
for the worst-case scenario, that is how soon the interest
rate and monthly payment could rise and to what amount.
- The amount of any prepayment penalty.
- Whether the lender will "lock in" the interest
rate offered if market rates rise between the time you apply
and when your loan closes.
Lenders will compete for your business. Let them know you are shopping
around, and negotiate to get the most favorable terms.
If you have a poor credit history or inadequate income and
assets to qualify for a more affordable mortgage, you may
qualify for a loan at higher rates and with terms disadvantageous
to you. Remember that your home is collateral for your mortgage
loan.
If you cannot make your payments, you could lose your home
as well as all the money you have already invested in it.
Be sure you can afford any mortgage you apply for.
USING HOME EQUITY LOANS
The "equity" in your home is the difference between the market
value of your home and the balance you owe on your mortgage
loan(s). Many lenders will loan you up to 85 percent of your
equity, but your home is collateral, so if you fail to make
payments on time, you can lose your home.
Home equity loans have lower interest rates than bank and
store credit cards and consumer installments loans because
they are "secured" by your home. One of the benefits
of the home equity loan is that you may be able to take the
interest payments as an itemized income tax deduction.
There are two types of home equity loans:
- A "second" mortgage usually has a fixed term,
fixed interest rate and fixed monthly payments.
- A home equity "line of credit" is "revolving"
credit, like a credit card. It usually has a variable interest
rate and may have a large "balloon" payment due
at the end of the loan. You can write checks against the
loan amount as you need to or access the loan with a special
credit card.
Different lenders offer home equity loans with widely varying
terms. Before you apply, ask several lenders to give you
in writing the following information on their loans:
- Whether the loan has a limited "draw period"
during which you can withdraw money against your line of
credit.
- When you will be required to repay the full amount.
- The annual percentage rate (APR). On a variable-rate
line of credit, the APR covers only the interest rate; other
fees are charged separately. On a second mortgage, the APR
includes other fees.
- All upfront and continuing fees not included in the APR.
- Monthly payment amount. For a variable-rate loan, you'll
need to know the "worst-case" scenario, that is,
how high the interest rate can go, how soon it can rise
that high and how high the monthly payment can go.
- Repayment terms during and at the end of the loan.
Compare this information for loans from several lenders
and choose the loan that best meets your needs. Lenders will
compete for your business, so negotiate to get a better deal
if you can.
If a balloon payment is involved, be sure you understand exactly how
it works. On some loans, for example, monthly payments cover
only interest costs, not the loan principal. If you borrow
$10,000 and make periodic payments that only cover interest,
you may have to make a final payment of $10,000. If you are
unable to pay that amount when the final payment is due, you
could lose your home.
Because you can lose your home if you don't make equity
loan payments as agreed, you should not use an equity loan
for ongoing day-to-day expenses. Use it only for major one-time
expenses like home improvement projects, education or medical
bills.
EDUCATION FINANCING
Whether your post high school education is vocational or
academic training, the required years of study and can be
very expensive. A college education can cost more than $100,000
at a private university. Among colleges and universities,
government-sponsored schools, especially two-year community
colleges, have the lowest costs. A vocational education, to
prepare students for a particular trade such as electronics,
cosmetology, medical assisting or bookkeeping, can require
less than four years to complete but still cost as much as
$20,000.
Education costs include:
- Tuition - the charge for instruction and use of facilities
- Room and board - charges for housing and meals
- Various fees, such as those for activities, parking, health care
- Books and supplies
- Transportation
The best way to ensure your child has enough money to pay for a post-secondary
education is to start setting aside savings every month when
the child is a baby. Starting early will allow you to put
your funds in federally insured savings and let compound interest
add significantly to what you save. For example, $29 invested
every month at 5 percent interest will yield $10,000 after
18 years. If you start saving when your child is 12, you will
need to save $119 a month at 5 percent to have $10,000 when
your child is 18.
There are many sources and types of financial aid available to qualified
post-secondary students. They include:
- Grants and scholarships that are gifts that do not need to be repaid.
- Government and private education loans that usually do not have
to be repaid until the student is out of school. Failure to repay
a loan can ruin a student's or parent's credit rating and make future
borrowing difficult.
- Work-study programs offered by some educational institutions to
allow students to work while they are in school, often on campus,
to offset some costs.
Students may qualify for financial aid based on the following:
- Merit, that is, the student's excellent academic, athletic or artistic
performance in high school
- Financial need
The best sources of information on financial aid are:
- The world-wide Web. Go to http://www.students.gov
as a starting point.
- High school counselors
- Individual schools' student financial aid offices
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