What You Pay When You Borrow Money
Whenever you need to borrow money, you will always be paying back more than what you borrow. This goes for all loans whether they're fixed-term loans that give you a principal amount that will end once the entire loan is repaid, or lines of credit that automatically renew. This is why you always need to make sure you're actually using a loan for something you need and not taking one out without knowing what you'll be paying each month and how you should budget for it. The most important things to know are the kinds of interest and fees you'll be paying as the cost of borrowing money.
Why Lenders Charge Interest and Other Fees
Whenever you're borrowing money, that is money that the lender cannot use while you're using it, and there is always the risk of losing it. Some loans even require collateral in order for you to borrow them because they involve a large principal amount, or they consider the borrower to be a high risk. Home mortgages and auto loans are usually always secured, while most short term personal loan options and credit cards are unsecured. But lenders of both types of loans still will charge interest as a way to make money by lending money.
Basically, understanding interest vs. principal is easy because the principal amount is the initial amount you borrow, and interest is a small percentage of that amount that you pay back over time. Keep in mind that there are some loans that have simple interest, which is an interest rate that stays at the same rate each year, though usually, you'll pay a certain amount of it each month.
Another thing to consider is compound interest, which is interest that can be charged on top of unpaid interest. Usually, you'll see this noted in a loan'sannual percentage rate (APR). What will usually determine your APR, as well as other charges, is how much of a risk you are. That's determined by your credit report which if it's good and you have a history of low debt and paying on time, you'll get a lower interest rate. But if it's not too good and you've had struggles, your interest rate will be higher.
What Kind of Fees You Can Expect
Along with interest payment fees and principal payments, the lender has to recoup losses that come with missed payments. If you pay late you can expectlate payment fees. These are the most common kind of charges that people think of when associated with loan costs. You don't want too many late payments because they can raise your interest rates, hurt your credit score, or in worst case scenario cause a default which could really get you in trouble.
Defaulting on a secured loan could mean your collateral will be lost, but even an unsecured loan default could land you in collections. Also be careful about early payment fees if you're on track to pay off your loan before its end date because some lenders charge these to avoid losing money they would have made on accrued interest. If you're careful, there are ways to get around these. But the bottom line is to make sure you're aware of all fees before signing on the dotted line.
Lending money is a business model that goes back thousands of years. In order to make money, lenders have to charge borrowers for the privilege of getting a loan or line of credit, a charge which takes the form of interest. But there are other fees and costs to consider. It’s important for borrowers to be aware of the total cost of borrowing money before agreeing to do so and understanding the consequences of not paying their debts.