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opportunity to spend money is everywhere. There is no shortage of places
that will take your cash. In fact, to keep the money flowing out of your
wallet, banks and merchants continually come up with easier ways for you
to spend it.
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But
when it comes to borrowing money, suddenly the cash pipeline doesn't
operate so smoothly. Money becomes a more complex issue with documents
and terminology that practically require you to have both an MBA
and Law degree to fully understand.
Before you get dazed
by the paperwork and lost in the legalese of loan products, here
is a quick lesson on loans.
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- The Basics
- when you get a loan, you are borrowing money with a promise to pay
back the original amount (principal) plus an extra amount as a fee (interest)
for the privilege of borrowing. The amount you pay in interest is normally
a percentage of the loan amount -- the interest rate. (Example: If you
borrow $200 with an interest rate of 10%, you will pay back $2200. That
consists of the $200 principal plus $20 interest.)
- Loan Categories
- From a broad perspective, loans fall under one of two categories:
a) Installment loans and b) Revolving Credit loans.
- Installment loan: The
installment loan is probably what most people think of when talking
about a loan. Money is borrowed from the bank in one lump sum and
normally paid back in installments, or increments, over a set period
of time. The sum paid back can include both the principal plus interest
or the payments may contain interest only with the principal being
paid all at once in the last loan installment, known as a balloon
payment.
- Loans that fall under
this category include mortgages, personal loans, and auto loans.
- Revolving Credit loan:
Revolving Credit (also called Revolving Line of Credit or Credit
Line) is a loan where a lender allows someone to borrow money up
to a specific limit, called the credit limit, whenever money is
needed. The borrower draws down the credit limit every time an amount
is borrowed. The borrower can use as much of the credit as he or
she wants. When a repayment is made, the available credit rises
by the paid amount.
Example: Borrower gets a credit limit of $1000. $100 of the credit
is used to buy merchandise. The credit limit now decreases by $100
to $900. A day later, the borrower decides to borrow another $100
decreasing the credit limit to $800. Next month, borrower pays back
the $200 plus interest and the credit limit goes back to the full
$1000.
Loans that fall under
this category include credit cards, home equity line of credit
(HELOC), and business lines of credit.
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Rates
As you already learned, the interest that you pay is calculated
as a percentage of the principal amount. Some loans have a fixed
interest rate while others have an adjustable rate of interest.
A loan with a fixed interest
rate means that the interest you pay stays the same throughout the
life of the loan.
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The adjustable rate loan, on
the other hand, has an interest rate that can fluctuate from period to
period. That means a borrower can expect to pay more or less interest
as the rate fluctuates. The rate's movement is tied to indexes that track
a basket of interest bearing investments. As the interest rates of the
index moves up or down, the interest rate on your loan is adjusted accordingly.
There you have it. You just
completed your lesson on loans. Now that you have a grasp of the basics
of loans, you will be better prepared to understand the minute details
of the loan that you need.
Jon Galanty is a financial
writer for eMoneyCentral.com. Visit http://www.emoneycentral.com to find
out more about loans and to get other great money tips.
Copyright 2005 JakeTruman.com
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