Sometimes we don’t have the money we need to accomplish a goal. Borrowing money can help, but if we aren’t aware of how the system works, it can create bigger problems for us.
Among friends, borrowing money seems easy – you just pay them back. However, we sometimes need to borrow a large amount of money from a financial institution, maybe for a home, a car, or education. Understanding how these relationships work is a key to being responsible with your money.
Let’s say you need to borrow $10000 from a bank. As long as you meet their requirements, the bank is happy to loan you this money because when you pay it back, you’ll have to pay a fee. This is how the bank makes money – it’s called “interest.” When you borrow money, the interest you pay is usually a percentage of the total you borrowed. This percentage is called the “Interest Rate.” You’ll see this rate referred to as the Annual Percentage Rate or APR, which is the interest and fees you’ll pay over a year for borrowing money.
Let’s see how this works for Rachel. She’s a musician who needs to borrow $10000 to produce her new album. $10000 plus interest is a lot of money to pay back, but she doesn’t have to do it all at once. To make it more affordable, she pays it back in monthly payments. Each month, she’s paying back part of the money she borrowed plus part of the interest. It adds up over time.
This way, Rachel can see if she can afford to pay back the loan on a monthly basis. She found one loan that had a 5% APR with a 1 year timeframe. To pay it back, she would have had payments of $856 per month. It was too much! With what Rachel earns she would run out of money in just six months.
To avoid serious problems and owing even more money, she kept looking. Eventually, she found the right loan for her – a lower APR and longer timeframe. She found that spreading the payments across a longer timeframe meant less to pay each month.
Before signing on the dotted line, she was careful to understand all the terms of her loan. She learned that some interest rates could change during the loan which could impact her monthly payments. Because she had a fixed budget, she made sure the interest rate for her loan wouldn’t change.
While Rachel was asking questions, she learned the rules as well, because breaking the rules can cause an affordable loan to become a big headache. For instance, if she pays late, she may owe the bank more money. She made a promise to herself to pay on time and avoid any late fees. It was wasteful.
It was clear to Rachel that without care, problems could snowball. Changing APRs and late fees could have made her loan impossible to afford. Because Rachel took the time to find the right loan for her, she was able to pay back the loan on time and publish her new album. Yaay!
Borrowing money can help you accomplish your goals, but only if you’re realistic about what you can afford. When it comes time to find a loan, discuss it with a financial professional and ask questions. Learn about your payments and terms. It’s up to you to make sure you know the rules and get a loan that fits your needs.
This video introduces the risks and benefits of using a bank to borrow money. It tells the story of Rachel who reaches her goal of publishing an album by making smart decisions based on interest rates and timeframes. The video includes:
NEVER miss a new video.
Our newsletter is monthly and kind of awesome.