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A Little Lesson on Loans

The 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.

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.

1) 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) slick cash loan 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 $100 with an interest rate of 10%, you will pay back $110. That consists of the $100 principal plus $10 interest.

2) Loan Categories

From a broad perspective, loans fall under one of two categories: a) Installment loans and b) Revolving Credit loans.

a) 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.

b) 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.

 

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