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Why Lenders Lend |The Language of Loans |Kinds of Loans |Cost of a Loan why lenders lend
Lenders are willing to make loans because they make money on the deal.
When you take a loan, you have to pay back the money -- called the principal -- plus a fee -- called a finance charge -- for using it.
Lenders charge a percentage of the principal as their fee. The percentage varies, depending on current interest rates and the type of loan. Some lenders offer small discounts, called preferred customer rates, on the cost of a loan if you agree to open an account with them.
Loans have a specialized vocabulary that you need to be comfortable with if you plan to borrow money.
amount financed
is the amount you are borrowing -- or the principal. However, you may not actually get that whole amount. For example, the lender may require you to use a part of the loan amount to pay off another loan, or have you buy insurance to cover the loan if you die.note
is another word for loan.finance charge
is the interest you have to pay on the amount you borrow.co-signers
agree to repay your loan if you don't pay it. Lenders sometimes want someone older, with an established credit history, to co-sign (or guarantee) your loan.prepayment
means paying off a loan before it's due. Most lenders allow it, but some charge a prepayment penalty, usually about 2% of the amount borrowed. In many states, though, it's illegal to charge such penalties.late fee
is the extra amount you may have to pay if your payment arrives after the date it's due.defaulting
means not paying the loan according to the terms of the loan agreement.collection costs
are penalties a lender charges if you default. They may include the expense of hiring a collection agency or lawyer.security
is property (called collateral) which the lender can seize and sell if you fail to repay the loan. The property used as security, such as a car, is often what's being purchased with the loan. Money you have in a bank account, as well as stocks and bonds, can also be used to secure a loan. If the lender takes the amount you owe out of one of your accounts, that's known as a Set Off.
installment loans Most of the loans people take to buy a car or pay tuition are installment loans.
With an installment loan, you borrow the money in a lump sum and repay it in specific, pre-set amounts, or installments, on a regular schedule, usually once a month. Installment loans are also called closed-end loans because they are paid off by a specific date.
Each time you need to borrow, you apply for a new installment loan.
lines of credit Lines of credit let you borrow on a more flexible schedule.
A personal line of credit lets you write a check on your loan account for the amount you want to borrow, up to a limit set by the lender. The credit doesn't cost you anything until you write a check, but then you begin to pay interest on the amount you borrowed. You must repay at least a minimum amount of the loan, plus interest, each month, but you can repay more, or even the whole loan amount, whenever you want.
Lines of credit are known as revolving credit, because whatever you repay becomes available for you to borrow again. You don't have to reapply.
fixed-rate loans With a fixed rate loan, the interest rate and the monthly payments stay the same for the term, or length, of the loan.
The advantage of a fixed rate loan is that there are no surprises: the cost of the loan won't increase, so it's easy to budget the payments.
One disadvantage, though, is that you don't benefit if interest rates go down, because the rate at which you pay is fixed. Another is that the interest rate on a fixed rate loan is higher than the initial rate on an adjustable loan.
Most installment loans have a fixed rate.
adjustable rate loans An adjustable rate loan has a variable interest rate, usually pegged to a bank or government rate.
When interest rates go up or down, the rate you pay on adjustable rate loan changes, and the monthly payment changes also. Those changes can be as frequent as every month, every six months or once a year. Or, if rates stay put, there may be no change for a period of time.
The advantages of variable rate loans are that the initial interest rate is usually lower than on a fixed rate loan, the overall costs of the loan decrease if rates drop, and there's usually a cap, or limit, on amount the rate can go up in any one year.
The disadvantage is that variable rate loans are vulnerable to rate hikes, which can make it hard to budget. Plus, adjustable rate loans aren't always available.
other sources of loans Banks and credit unions are common lenders, but there are other places to look for a loan.
You can sometimes borrow money on your life insurance policy, if you have one, or from certain kinds of retirement funds. And if you want to invest in stocks or bonds, you can often make arrangements with your broker to use a margin account.
Sometimes the company that's selling you something--like a car or a boat--will offer a loan too. It's convenient, and can be inexpensive if the dealer has a big promotion. But there can also be hidden costs.
Generally the most expensive source for loans is a small loan company.
Loans are handy, sometimes essential, but rarely cheap.
Many people think that the cheapest loan is the one with the lowest interest rate and the smallest payments. But that's not the whole story. The length of the loan and the fees you pay are essential in figuring the loan's real cost.
a loan's real cost The lender has to let you know what you'll pay for your loan.
Lenders must tell you what a loan will actually cost, expressed as an annual percentage rate (APR). The APR combines the fees with a year of interest charges to give you the true annual cost.
Every lender is also required to provide a Truth-in-Lending statement, a total cost disclosure before a loan is made. This is the only place to see in dollars and cents what the loan will actually cost you over its entire term.
loan fees Be careful to ask about all fees -- they add up very quickly and can substantially increase the cost of your loan.
- application fees cover processing expenses.
- attorney fees pay the lender's attorney. Fees for your own attorney are extra.
- credit search fee covers researching your credit history.
- origination fee covers administrative costs, and sometimes appraisal fees.
the cost of taking longer to repay The term of your loan is crucial when determining cost. Shorter terms mean squeezing larger amounts into fewer payments. But they also mean paying interest for fewer years, which saves a lot of money.
Consider, for example, the interest for 3 different terms on a $13,500 car loan at 12.5%:
3 Year 4 Year 5 Year Number of monthly payments: 36 48 60 Amount of each payment: $451.62 $358.82 $303.72 Total interest paid: $2,758.32 $3,723.36 $4,723.20
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