Credit Basics: Four Key Points about Loans
by Cindy Diccianni RN, CSA, CLTC, Financial
The reason for having good credit is to get
a loan when you need one. A loan can be large
or small, have a long payment schedule similar
to a mortgage, or a short payment period,
like a demand note. Loans can also be instantly
available through a credit card or they can
require you signing a contract with many documents.
Generally, there are four key points to all
1. How much you can borrow
The amount you borrow is called the "principal."
Sometimes you borrow the principal all at
once, and other times, for example with credit
cards, you have a "line of credit"
that lets you borrow up to your "credit
limit" at any time.
With credit cards and charge cards, if you
pay off the balance in full each month, there
are no interest charges and any principal
you repay becomes available to be borrowed
again so long as your credit remains in good
standing. This agreement to let you borrow,
repay, and borrow again is called "revolving
credit." In a loan document and on most
card statements, you may see the words "amount
financed", which is simply the amount
that you have borrowed.
The most common cost of a loan is the interest
or finance charges. Usually, your payments
are split with part going to repay the principal
and part going toward the interest charges.
Often there are fees of various kinds. Some
credit cards charge annual fees (like dues)
that can sometimes be waived for special promotions
or upon your request. Many also charge fees
for cash advances, mortgage lenders charge
"points" and other connected fees
for appraisals, closing costs, and more.
All lenders are required to show you the
annual percentage rate (APR). This takes into
account the interest rate plus certain fees
to show the actual cost of the loan for the
first year. This is why the APR is slightly
higher than the loan rate.
3. The payment plan
A payment plan has three parts: the length
of time you're given to repay the loan, the
schedule of payments, and the amount of each
payment. Charge card issuers give you the
shortest time 30-60 days. Mortgage lenders
give you the longest-up to 30 years. Credit
card issuers let you take as long as you like;
if you always make the minimum payment required,
the loan can go on for what seems to be forever.
Most payments are made once a month with the
amount fixed or adjustable based on the balance
and interest rate (if it is a variable interest
4. What if you do not repay
Failing to repay a loan on schedule can
put you in default with the lender who is
then faced with finding another way to get
repaid. The lender can place the loan in collections
or sell any collateral associated with the
loan. If your credit report shows you to be
a risk, the lender will want "security."
In a secured loan, you will give the lender
the right to sell a specific property, home,
car, etc. in order to recoup the money owed.
By law, creditors cannot ask you to pledge
as security any clothes, furniture, or other
person belongings unless they are the actual
items you are buying on credit. Also, if your
car is repossessed, you are entitled to anything
left in it (within 24 hours). This gives the
lender a sense of security and some incentive
to lend you the money. Generally, the collateral
is the property you are buying with the loan-homes,
cars, or large household items. In an unsecured
loan, there is no collateral and the lender
must trust that you will repay the loan as
Types of Loans
There are many types of loans and virtually
anyone can lend you money, from a family member
to a large banking institution. Choose the
lender based on your reason for wanting the
money. Some lenders will extend credit only
if you will use the money in ways that further
their business. These include department stores,
retail chains, and car dealerships. Basically,
they are middlemen or dealers for their products.
They arrange loans to facilitate the sale
of their goods.
Mortgage lenders lend money only if it is
used to buy a home. The money they have to
lend has been earmarked for home loans and
is priced accordingly. They secure their interest
by using the home as collateral and by the
increase in value the home will gain over
Student loan lenders insist you use the money
for this specific purpose. There is no tangible
property to secure which is why the federal
government backs many of these loans through
agencies like Sallie Mae.
Asset-backed loans are loans through banks,
securities brokers, or insurance companies.
They are backed by some type of underlying
security such as savings or checking accounts,
stocks, and/or life insurance cash values.
Home equity lines of credit are loans that
are backed by the equity (increased appreciation)
of your home.
As you can see there are many ways to borrow
money. The key point is to remember that these
loans must be paid back in a timely fashion
and by the specific terms of the loan. Failure
to do this will result in a lowering of your
credit worthiness and that will result in
higher loan rates or the possibility of not
getting a loan. With a good credit rating
you can borrow at the lowest rates available
and save even more. To check on your credit
report log on to www.freecreditreport.com
for more information. As always, it is best
to consult with your financial advisor before
making decisions that will impact your financial
situation. S/he will know what is best for
you given your situation.
Cindy Diccianni is a Registered
Nurse, a Certified Senior Advisor (CSA), a
Certified Long Term Consultant (CLTC), a Registered
Investment Advisor and a Registered Representative
with Leigh Baldwin & Company member NASD
and SIPC. She is a co-founder of Nurturing
Your Success, Inc. Her passion is assisting
clients in creating financial independence.
You may visit Cindy at www.nurturingyoursuccess.com,
write to her at Cindy@nurturingyoursuccess.com
or call her directly at (610) 251-9393.