|
|
|
|
Ezra Taft Benson advised, “Sound business debt and reasonable debt for education are elements of growth. If you must incur debt to meet the reasonable necessities of life—such as buying a house and furniture—then, I implore you to value your solvency and happiness, buy within your means.”
At a very early age we learned about sharing and “lending” things to others for personal enjoyment. For example, we might lend our bike to a friend whose bike is broken. Or, we might lend our favorite Church video to our neighbors to watch for Family Home Evening.
That same principle is applied to money. When talking about lending or borrowing money it is known as a “loan.”
Where can you borrow money?
Parents and Family
Friends
Credit Unions
Banks
Other Financial Institutions
Before taking out a loan, ask yourself the following questions:
Do I really need this item or is it just something I want?
Do I really need to have this item right now?
Can I save my money and buy this later with cash?
Is it worth the time I will spend making the money to pay back the loan?
Is there a better use for my money right now?
How much interest will I pay over the life of the loan?
Before getting a loan, discuss these questions with a parent or other trusted person with experience who will give you honest, wise feedback. If you have this conversation and still feel good about the loan, you'll be much more likely to make a wise decision.
The language of loans
Interest: The cost of borrowing money from a lender. Interest charges are usually shown as an Annual Percentage Rate (APR) or a percentage of the amount you are borrowing. The higher the APR, the more interest you will have to pay to borrow money.
For example, If you were to borrow $1000 for 1 year at a 5% APR, your interest charge (sometimes called a finance charge) would be 5% of $1000 or $50. The total amount you pay back would be the $1000 you borrowed, plus the $50 interest charge, for a total of $1050.
Term: The term of the loan is the length of time that you have to repay the loan. For example, a common term for a car loan is 60 months, meaning a borrower has to make a payment every month for 60 months (or 5 years) to repay the loan.
Default: Breaking a loan agreement or the terms of a loan contract. If a borrower misses a payment or doesn’t pay back the loan, the borrower is in default. When a borrower is in default, the lender can go to court to sue for repayment, garnish (or forcibly deduct) the payments from the borrower’s salary, or in the case of a car or home loan, take ownership of the borrower’s car or home.
Example of the true cost of a loan— buying a car
To understand loans, let’s consider the example of getting a loan to buy a car, since for many of us, a car is our first major purchase that requires a loan. Before even looking for a car, you should first consider all the costs associated with owning a car:
Registration and Inspection Fees: You should plan on paying property taxes, registration fees, emissions and safety inspection fees, licensing fees and other fees each year. Check with your state or local government for specific information on these costs which can be hundreds of dollars per year depending on the age and type of car.
Insurance: Many factors will effect how much you will pay for auto insurance. New, less-experienced drivers will pay more for their insurance than those who have been driving for years. Drivers with perfect driving records will pay less than drivers with a history of speeding tickets, accidents and other traffic violations. Insuring an older car will be less expensive than a newer car. A basic sedan costs less to insure than a sports car or SUV. Because of these factors, your insurance can sometimes cost more than your monthly car payment. Talk with your insurance provider for specific costs.
Gasoline: Keep track of how many miles you drive in a month so you can estimate how much you’ll spend every month filling up you car. For example, the average person drives at least 1,000 miles per month. If a car averages 25 miles per gallon of gasoline and gasoline costs $2.25 per gallon, you can expect to spend at least $90.00 per month in gasoline alone.
Regular Maintenance: Brakes, tires, and just about everything else on your car need some kind of periodic maintenance. And unless you know how to change your car’s oil and perform other regular maintenance, you’ll probably have to pay a mechanic to do it all for you. You should plan on saving some extra money each month to pay for these expenses to keep your car running well. Otherwise, you’ll end up spending even more on repairs.
Repairs : Even the most reliable and well-maintained cars occasionally need repairs. You should plan on saving extra money each month for repairs so that you don’t have park your car and walk, or worse, beg for rides. If you don’t have to use your savings for repairs, then you simply have extra money in the bank to use toward your next car. Eventually, you might not even need a loan to buy a car!
After you’ve decided that you can afford owning a car, it’s time to examine if you can afford borrowing money to buy a car. The table below shows various loan amounts, loan terms, and the monthly payments for each term.
| Monthly Payments at 5.00% APR |
| |
Loan Term |
| Loan Amount |
1 Year |
2 Years |
3 Years |
4 Years |
5 Years |
6 Years |
| $5,000 |
$428 |
$219 |
$150 |
$115 |
$94 |
$81 |
| $10,000 |
$856 |
$439 |
$300 |
$230 |
$189 |
$161 |
Notice how the monthly payment is lower when the loan term is longer. This is how people can afford to buy expensive items like cars and homes. But there’s a price. Look at the next chart to see how much interest you will pay on the loans in the table above. This is the true cost of the loan.
| Monthly Payments at 5.00% APR |
| |
Loan Term |
| Loan Amount |
1 Year |
2 Years |
3 Years |
4 Years |
5 Years |
6 Years |
| $5,000 |
$136 |
$265 |
$395 |
$527 |
$661 |
$798 |
| $10,000 |
$273 |
$529 |
$790 |
$1,054 |
$1,323 |
$1,596 |
While the monthly payments may seem affordable, the interest charges can add up quickly. It’s important to make sure you can afford not only the monthly payment of the loan, but also the total cost of the loan as shown in the chart above. If the monthly payment or the total interest charges seem a little high, you may want to think about buying a less expensive car now and saving your money for a nicer car in the future.
Applying for a loan
You need to be 18 to apply for a loan. Once you’ve decided you can afford a car payment and maintenance costs, you’re ready to apply for a loan. Loan applications can be obtained online, in a credit union branch, or over the phone. The application requires information such as name, address, income, employment history, and a list of current loan payments. In addition to submitting the application to a loan officer, you’ll also be asked to provide copies of pay stubs to prove income and employment.
Before granting a loan, loan officers will review your credit history or credit report. A credit report lists all of the loans a person has had for the past seven years. It shows if you’ve made your payments on time or if they’ve been late, how much debt you currently have, as well as what kinds of debt you have (car loans, credit cards, home loans, cell phone bills, etc.).
Based on the information in your credit report, credit bureaus (organizations that keep track of everyone’s credit histories) will assign you a credit score. The higher your score, the more likely your application will be approved with a low interest rate. The lower your score, the more likely your application will be approved with a high interest rate, if you are even approved at all. In addition to making your payments on time, the key to building and maintaining a good credit score and getting the best interest rates is by borrowing in small amounts and by not borrowing too often.
If you haven’t had many loans or if you haven’t worked at the same place for very long, you may be asked to add a co-signer to your loan. A co-signer is a person who agrees to pay your loan if you don’t pay. Parents, relatives or trusted friends are often co-signers, but anyone can be a co-signer as long as they are at least 18-years old, have a strong credit history, stable employment, and enough income to pay all of their own debts plus yours if you don’t.
If you miss a payment or make a payment after the due date, you may be charged a late fee. You will also be reported late to the credit bureau, lowering your credit score and limiting your ability to get loans in the future. You may even be in default which can bring even more serious consequences (see the Language of Loans above).
If you keep making your payments on time your credit score will improve. You will be able to borrow more easily when you really need it for things like education or a home.
Words to the Wise
Where possible, it’s better to pay cash for purchases than to borrow.
Loans are helpful when making large purchases items like a reliable car, a home or an education.
When buying a car, determine the total cost of owning a vehicle before applying for a loan.
Financial institutions and car dealers will often lend you more money than you can really afford. Let your budget determine how much of a loan you can afford, not car dealers and financial institutions.
Once you have a loan be sure to make all of your payments on time!
About the Author:
Connon Williams is our Assistant Vice President of Service and Sales. He enjoys hiking, camping, fishing, movies, music, and Star Trek.
|
|
