Loans and Financing 8.27

LOANS AND FINANCING

Building your credit forms the foundation of your financial life, and how your credit is rated determines your financial reputation. When you have good credit, you inform lenders and banks that you can be trusted to repay a loan or other forms of credit. Your credit may influence where you live and how much you pay for your home and your car, it can affect your employment, and even your monthly bills. To qualify for a loan or credit card, cellphone service, or rent a car, you need to have an established credit history. This lesson provides a comprehensive overview of the different types of loans, loan qualification criteria and financing options. There are many ways to build and maintain a good credit history, and although it may seem overwhelming or unnecessary, you may be surprised by how many aspects of your life depend on having good credit.

CREDIT AND LOANS

Loan ? A loan is money that you borrow from a lender and promise to pay back on a set schedule. Interest ? When you borrow money, you make a promise to pay back the money you borrowed plus some extra. The extra amount is called interest. Interest is your cost to borrow the money. Credit ? Credit is the ability to borrow money and pay it back later. Credit is important because it:

? Can be useful in times of emergencies. ? Is more convenient than carrying large amounts of cash. ? Allows you to make a large purchase such as a car or house and pay for it over time. ? Is the record of how you manage your credit and may affect your ability to obtain

employment, housing, and insurance.

Important: Loans must be repaid. If you are unable to make your loan payments and your loan is delinquent, you are at risk of defaulting. There are serious consequences to your credit score and finances if your loan becomes delinquent or if you default on your loan. It is critically important to understand loan delinquency and default to manage your debt and avoid unnecessary financial stress.

Delinquency ? Your loan becomes delinquent after you miss a payment and remains delinquent until you repay the amount past due. After you pay all overdue amounts (including fees or charges related to the delinquency), payments will resume as normal.

? As a consequence of delinquency, your credit score will be negatively impacted. ? If you are unable to repay your loan(s), you can apply for temporary deferment or

forbearance, which allows you to temporarily postpone or reduce your monthly payments for student loans. For more information about deferment or forbearance, visit .

Default ? When you are unable to pay a loan according to the terms agreed upon, you enter default. The point at which a loan is considered in default depends on what type of loan you were issued. For example, the majority of federal loans are considered in default after you fail to make payments on the loan for 270 days.

? As a consequence of your loan's default status, the remainder of the loan balance may be due in full, ending any installment payments. More seriously, default status is extremely detrimental to your credit score and your ability to borrow money in the future. You may now have greater difficulty obtaining a mortgage, buying homeowners insurance or renting an apartment.

? You can avoid defaulting on your loans by immediately taking action when you reach delinquent status.

SECURED AND UNSECURED LOANS

Secured loan ? The borrower pledges to repay the loan (gives collateral, or something of value, to the lender for the loan). A lender may automatically take possession of the collateral in the event the loan is not repaid as agreed. The most common types of secured loans are car loans and mortgages. Unsecured loan ? The borrower does not give the lender collateral. If you default?or are unable to repay a loan as agreed?the lender is unable to automatically seize your property. The most common types of unsecured loans are student loans and credit cards.

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ASSETS

An asset is something valuable like a car, a savings account or your home. Some items generally cannot be used as collateral, unless they are used to secure the purchase of that item itself. These include:

? Furniture for your home ? Clothing ? Kitchenware

Guarantee ? A guarantee is a form of collateral. For example, co-signing is a form of guaranteeing a loan. If you have no credit history, you may ask someone else to co-sign a loan. The cosigner is then equally responsible for the loan's terms. If you are unable to repay the loan as agreed, the cosigner must pay the unpaid loan balance plus interest.

TYPES OF LOANS

Consumer Installment Loans ? Consumer installment loans are used to pay for purchases and other expenses for you and your family. An example would be an auto loan. The automobile you are purchasing is used as collateral for the loan. With a consumer installment loan, you are borrowing a fixed sum of money. You pay it back with equal payments over time. Credit Cards ? Credit cards give you the ongoing ability to borrow money for household, family, and other personal expenses. Having a credit card allows you to buy things and pay for them later. Remember that if you are not careful in spending, you can get into big trouble?you could be burdened with credit card debt. You need to be sure you can make the minimum monthly payment on your credit card bill. Home Loans ? A home loan is designed for the specific purpose of buying a home. It is secured by the home you are buying. That means you could lose your house if you do not repay your loan as agreed. Home Refinancing ? Home refinancing replaces an existing home loan by paying it in full and replacing it with a new home loan. A cash-out refinance loan allows you to borrow more money than is owed on the loan being replaced. Homeowners often refinance their home loans to obtain

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a lower interest rate, to get money for home repairs or for other personal needs such as investments.

COSTS ASSOCIATED WITH GETTING A LOAN

Fees ? Financial institutions may charge fees for activities such as a review of your loan application. They may also charge you a penalty fee if you violate the terms of the loan agreement. For example, a lender might charge a $30 late fee when you do not pay your bill on time. The lender might also charge other fees. For instance, a credit card company might charge you an annual maintenance fee or a service fee when you get a cash advance. Interest ? The amount of money a financial institution charges for letting you use its money is called interest. The interest rate can be either fixed or variable. In general, fixed rate loans stay the same throughout the term of the loan. Variable rate loans might change during the loan term. The loan agreement will show the details of the interest rate.

TRUTH IN LENDING LAW

Amount Financed ? On an installment loan, this is the amount of credit the lender is letting you borrow. The amount financed will generally be the same as the amount of the loan, unless you have prepaid any loan fees or finance charges. Annual Percentage Rate (APR) ? The APR is the cost of borrowing money. It is the cost of credit stated as an annual percentage rate. It reflects both interest and other fees and costs defined as finance charges. It is the primary tool you should use to compare lending options. Fees ? Lenders must disclose the fees they charge for things like late payments. Make sure you check out what fees could be charged and how to avoid the fees. Grace Period ? Grace period is the number of days you are granted to pay your credit card balance in full before the credit card company starts charging interest. Without a grace period, interest will be charged from the date you use your card or from the date each transaction is posted to your account.

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Financial Tip ? If you have a good credit history, you can probably find a credit card with no annual fee. If your current card has an annual fee, call your lender and ask them to waive it. They might do this rather than lose a good customer.

TYPES OF ALTERNATIVE FINANCIAL SERVICES

RENT-TO-OWN

Rent-to-own services let you use an item for a period of time by making monthly or weekly payments. If you want to purchase the item, your rental payments will be partly credited toward the purchase price. The store will set up a plan for you to rent the item until you pay enough to own it. If you choose not to purchase, you would simply be renting the item to be returned at the end of the rental period. The store is the legal owner of the item until you make the final payment. If you miss a payment, the store can take the item back. If this happens, you will not own the item, and you will not get your money back. Rent-to-own agreements are technically not loans, so no interest is charged. However, the difference between the cash price (if you were to buy the item outright that day) and your total payment (the total of your rental payments over time) is like the interest you pay on a loan. Generally, using rent-to-own services is more expensive?sometimes much more expensive? than getting a consumer installment loan to buy the item.

PAYDAY LOANS

Payday loans (or cash advance loans) are short-term loans (usually up to two weeks). You write a check payable to the lender dated two weeks from now and receive cash that day. The loan service cashes the check on your payday to pay the loan in full. You can also go into the loan office and pay your loan with cash, at which point the lender returns your uncashed check to you. You must be careful of payday loans. They are usually made to people who need money right away and plan to pay it back with their next paycheck. Payday loans can be much more costly than they appear at first glance. If you do not have the money to pay the loan within the agreed-upon time period, the lender will renew the

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