Borrowing money can help you manage your way out of a tight spot, but doing so without knowing all the facts can make your finances even tighter in the long run.
“When faced with a financial emergency, most people don’t think through how borrowing money might affect them down the line,” said Susie Irvine, president and CEO, American Financial Services Association Education Foundation. “With so many options available, it’s relatively easy to get a loan, but the impact on your credit and what it actually costs you over time can vary a great deal.”
Two common forms of small-dollar borrowing are traditional installment loans (TIL) and payday loans. Understanding how each loan works can help you make the right decision for your financial situation.
Traditional installment loans are used for various purposes, such as meeting family emergencies, purchasing home furnishings or consolidating other debts. These loans are generally short-term. Most traditional installment loans range from $500 to $3,500, with the borrower paying equal installments at regular intervals over a determined number of weeks, months or years. A typical monthly payment is around $125. With regular, manageable payments of principal and interest, the borrower has a clear roadmap out of debt.
Payday loans are repaid in a single balloon payment at the end of the loan period. This payment is usually due in less than 30 days, most commonly 14 days. Payday lenders do not assess ability to repay, relying instead on a postdated check or on similar access to a borrower’s bank account as their assurance that the loan will be repaid. Although payday loans may appear to provide a quick and easy solution, a traditional installment loan is a more financially sound choice for most people.
Is an Installment Loan Right for Me?
When deciding whether to obtain an installment loan, consider the benefits and responsibilities. According to the American Financial Services Association Education Foundation, an installment loan:
- Obligates future income. You’ll be required to set aside a certain amount of future income for loan payments.
- Requires discipline. Borrowing wisely means not borrowing more than you can handle. Don’t let the thrill of buying or having a sum of cash obligate you to more than you can afford.
- Makes it possible to meet unexpected expenses. The ability to borrow and make affordable payments can be helpful if an emergency arises that requires extra money.
- Allows you to obtain products and services now and pay for them later. A loan can provide an opportunity to purchase bigger-ticket items and use them right away.
- Keys to Credit Success
The American Financial Services Association Education Foundation offers this advice to help ensure that your interests are protected when you borrow money:
Budget your money. Provide your monthly spending plan when you meet with creditors. It will help them make a responsible decision about the amount of credit you can afford.
Shop, shop, shop. Compare the costs of credit from different creditors. Shop for credit like you would shop for anything else.
Beware of “now or never” offers. If it’s a good deal, it will probably still be there after you’ve had time to think about it. Don’t be pressured into making a quick decision.
Ask questions. Don’t sign on the line until all your questions have been answered.
Read the contract. Don’t sign a contract that you don’t understand or has any blanks. A signed contract with blanks can be completed as anyone wishes and it will be legally binding.
Keep your contract in a safe place. It’s important to keep all paperwork relating to your credit obligations. If questions come up later, you’ll have your agreement in writing.
Make your payments on time and in full. This is one of the best ways to build a good credit history. Repeated late payments will trigger late payment fees, and hurt your credit report, which will make it difficult to obtain future credit.
Additional products are not required to get a consumer loan. Optional products that may be offered for purchase with your loan include motor club membership, term insurance or warranties.
Terms to know
When you take out a loan, it’s important to understand the complete cost of repaying the amount you’ve borrowed. It’s a good idea to compare offers from multiple creditors, and understanding these terms will help you calculate the real cost of borrowing to get the best deal. Here is a list of common terms from the American Financial Services Association Education Foundation.
Amount Financed: The total dollar amount of the credit that is provided to you.
Annual Percentage Rate or “APR”: A measure of the cost of credit expressed as a yearly rate.
Credit Insurance: Optional insurance that is designed to repay the debt if the borrower dies or becomes disabled.
Finance Charge: The dollar amount you pay to use credit.
Fixed Rate Financing: The interest rate and the payment remains the same over the life of the loan. Equal monthly payments of principal and interest are made until the debt is paid in full.
Length of Payment: The total number of months you have to pay the credit obligation.
Late Payment Fee: A fee that is charged when payment is made after its due date.
Monthly Payment Amount: The dollar amount due each month to repay the credit agreement.
For more resources to help you better manage your money, visit www.afsaef.org.
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