Basic Principles Of A Loan

Understanding the basic principles behind a loan can save new borrowers a lot of stress
and make the borrowing process easier. This article will explore some of those loan
basics.


A consumer loan is simply when a financial institution lends you money with the promise
(from you) that you will repay the money. Most loan payments include both principal and
interest.

The principle is the amount of money that you borrowed. Interest is the price paid for
borrowing money; this is usually expressed as a percentage.


In an interest-only loan, the interest of the loan is paid off before the principal. It
is important to understand this because many mortgages are interest-only loans. Using
this kind of loan allows the lender to make a faster profit on the loan, and in return
it also allows the lender to offer you lower interest rates.


Borrowers should understand that during the first years of an interest-only mortgage
the entire monthly payment goes toward interest. Because of this, there will be no
decrease in the amount of the principle that was borrowed. In some cases, the initial
interest-only payments are lower than the principal payments. This allows the borrower,
who expects to earn more profit over time, to obtain a larger loan.


Variable Rates versus Fixed-Interest Rates

Aside from interest-only loans, you may see offers for loans that are based on either
variable rates or fixed rates. Credit cards generally use either the variable or fixed
rates systems when calculating the interest.


Variable-rate loans are based on the prime lending rate, and then some additional
interest percentage is added in order to cover profits for the lender. Whenever the
Federal Reserve raises interest rates, your bank will raise your interest as well. If
the prime lending rate is low, variable rate loans and credit cards can be especially
competitive with fixed-rate loans.


Fixed-rate loans and credit cards offer you guaranteed interest rates that do not
fluctuate. You will know what your payments are each and every month based on the fixed-rate percentage of the loan that you took out. This offers consumers more emotional
security because they do not have to worry about their monthly bills increasing
suddenly.


All borrowers should understand that variable rates are different than teaser rates.
Teaser rates are temporary and last only for a limited time, usually three to six
months. Once that period of time is over, the rate will go up and so will your monthly
bill.


One of the most important principles behind a loan is establishing a good credit
history. The fastest way to get a poor credit rating is to not pay your monthly bill or
to be habitually late in paying your bill. These activities are usually reported to the
three big credit reporting agencies and this information will stay on your credit
history record for years to come. If you must take a loan out make sure that you can
make the monthly payments on time.


If you have any questions about your loan or the interest that is being charged ask the
credit person to explain it to you in detail. They are happy to do this. As a general
rule, try to keep your non-mortgage debt payments below 10-15% of your monthly take-home pay.

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