Hi! Thanks for writing! Here is some info about loans – hopefully I am not overwhelming you. When you borrow money, your dollars work for the lender at a much more efficient and lucrative pace because you will be paying higher interest than you will probably ever earn. If your credit is good and you own a home, you have lower-interest options like home equity loans, lower-interest personal loans, and credit card balance transfers or advances. Loans available to those with impaired credit include higher-interest personal loans (secured and unsecured), payday loans, auto title loans, and peer-to-peer loans, all of which can be expensive. I discuss each of these loan types below.
A “secured loan” means that you put up an asset such as your car or house as collateral for the loan. Rates tend to be lower for secured loans because lenders figure they can sell the house or boat to get back their money if you don’t pay the loan back. An unsecured loan is guaranteed only by your promise to pay it back. If you don’t pay, lenders will work to get their money back, but, as the saying goes “you can’t get blood out of a turnip.” So lenders run the risk never getting the money they lent to you back. That’s why they charge a higher interest rate on an unsecured loan.
If you borrow money for almost anything, you’ll probably see the acronym “APR” somewhere on the documents. In simple terms, APR means the percent you’ll pay in a year to borrow that money. Think about it this way – when you buy any kind of service, you have to pay something for it. Borrowing money is a kind of service, and you have to pay some amount for that service. If you borrow for a house with a home mortgage, the APR (or cost of borrowing) is pretty low – maybe 3%-5% in 2016. On the other hand, if you run a balance on your credit card, you may pay as much as 23% APR in interest and fees – that’s much more expensive. And if you get into a payday or title loan that you roll over a few times, your APR can be as much as 396%. You can see the incredible difference you might run into for the same “service” of borrowing $1,000. At 2% APR, you’d pay $20 in a year; at 5%, you’d pay $50; at 22% you’d pay $220; and at 396% you’d pay $3,960. So for the privilege of borrowing $1,000, you might pay between $20 at 2% and $3,960 at 396%. A high APR means that you are paying a lot to borrow money. Sometimes borrowers have no choice but to pay a high APR because they have a poor credit record and the lender is worried about the borrower not being able to repay the loan. When lenders consider borrowers as “high risk,” they charge more for lending the money.
Even though we are in a very low interest rate environment in 2016, it still costs more to borrow money than you can probably earn when you lend it. In other words, when you need to borrow $10,000, you could pay between 3% and 100%+ depending on the lender you are using. When you “lend” your money (by putting it in a bank, CD, money market account, or bond), you are going to earn somewhere between 0.01% and maybe up to about 5%. That’s why financial planners are so insistent on consumers getting rid of credit card debt – it can be as high as a 23% interest rate, which is a very expensive way to borrow money. Your invested money can make you between 0.05% and about 8% on average. But borrowed money simply costs more: home loan rates are about 3%; personal loans about 8%; credit card rates about 15% or more in 2016. Payday and other predatory loans cost even more: the APR for a $100 single-payment payday loan may range from 260.71% to 782.14% on 14 day terms.
Best wishes to you!
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