If you’re thinking of borrowing money, don’t just go to any financial institution, even the ones that have the most impressive ads. You need to take several things into consideration before settling on the one that’s right for you. Here are a few basic points that every borrower must know.
What Is A Consumer Loan?
Before we go any further, let’s first define a consumer loan. I mean if you are going to get one, you need to first know what it is. So, defined in very simple terms and without all the financial jargon - when you borrow money from a bank or any other financial institution for a personal purpose, it is called as consumer lending. The personal purpose can be anything from buying a car, to paying for education or even a loan to meet some unexpected expenses.
The basic premise is of course that you will pay the money back, and you will be charged interest on your principal amount.
Wait, don’t panic. Keep reading, and I’ll explain principal and interest as well.
The Principal Amount
Very simply put, the principal is the amount of money that you borrow. So if you borrow $5000, the principal is $5000.
The Interest
The interest is the price you pay for borrowing the money. The interest is usually represented as a percentage. In most cases, interest is charged annually and when you see “p.a.” next to interest percentage, it means “per annum” or per year. So you may borrow $5000@ 7.5% p.a. interest. This means when you’ve finally paid back all the money, you will have paid $5000 + 7.5% interest for every year you’ve had that money.
The interest rate you are charged can be “variable” or “fixed”.
Variable Interest Rates
When money is lent to you on a variable interest rate, how much you pay is determined by the prime lending rate. This means, your rates will fluctuate depending upon the market rates and the changes that the Federal Reserve makes. So if the Federal Reserve decides to lower the rates, you could end up paying lesser and vice versa. Therefore, your monthly repayments could vary from time to time.
Fixed Interest Rates
A fixed interest rate is exactly that – fixed. The lender gives you the money at a particular price and whether market rates rise or fall, you pay the same amount throughout the entire period. In this case, the amount you’re repaying every month will remain the same.
Interest Only Loan
An interest only loan is the common man’s way of describing what the lenders call “non-amortized lending”. When you’re borrowing money, if its “interest only”, then you will pay back the interest in installments over a set period of time. After this period expires, you will have to pay back the entire principal amount as a lump sum. As banks and lenders usually end a profit on this one, they tend to offer lower interest rates on such credit.
Credit History
Your credit history is the key to you being able to borrow money. But what exactly does this mean? If you’ve ever borrowed money before, you probably know what this means. But that’s not all that affects your credit history. Your credit card bills, phone, electricity, internet or any other bills may also make up your credit report. If you always pay all your bills on time then you probably have a great credit score. But if you’re always late or haven’t paid a few of them, chances are that they’re going to show up in your credit report.
This is because most of these companies will report to authorized credit reporting agencies, and they will keep a record of your payment habits. So when you go for another loan, this might work against you so make sure that you pay all your bills, and on time!
Unsecured And Secured Loan
Consumer loans are usually granted on an unsecured basis. This means the money is lent to on the basis of your good credit history or reputation and you sign a contract to pay the money back. When credit is secured, it usually means that you have to pledge an asset you own so you can get that money. We will discuss secured and unsecured loans in detail later.
These are the basics you need to educate yourself about before you set out to obtain a consumer loan.