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While it may be true that money makes the world turn, credit does most of the heavy work. The funds that individuals, businesses and governments borrow to fund new projects, purchases, hiring sprees and expansions is the economy’s lifeblood, providing livelihoods for millions of hard-working folks.
Not all loans are of equal merit, however. The financial crisis of the late 2000s made all too clear the perils of “easy money,” loans that for one reason or another should never have been made. In this case, the initial problem of mortgages made to people who couldn’t really afford them was compounded by a cascade of financial malfeasance that turned the loans into securities with uncertain but clearly-inflated values. These, in turn, were bought and sold on the world’s credit markets. When it became clear that many of the mortgages would never be repaid, the value of these securities collapsed and the whole house of cards came crashing down.
The cautionary tale of the recent financial crisis suggests that borrowing money isn’t always a good idea. However, there are some purchases that you simply can’t make without the help of a credit facility.
Since your credit score fluctuates based on your perceived ability to repay the money that you borrow, the credit-related decisions that you make today can affect your ability to borrow money at an affordable rate in the future.
Among the most flexible and easy-to-use credit facilities, credit cards allow you to make purchases without paying for them at the point of sale, and most have provisions built into their cardholder agreements that allow for a “grace period” of deferred payment for up to a month after you receive your monthly bill. When you make a credit-card purchase at the outset of a monthly billing cycle, you may not have to pay for it for nearly two months. In the day-to-day world of personal finance, that’s a comfortable span of time.
Unfortunately, it’s possible to get a little too comfortable with your credit cards and charge more than what you can afford to pay. To subtly encourage excessive behavior without inviting catastrophe, credit card companies often set their customers’ credit limits higher than what their income and net worth would suggest that they can afford. After all, the ability to buy products and services without paying for them plays into the natural human desire for instant gratification, regardless of the consequences.
Once you miss your first credit card payment, you’ll begin accruing interest at double-digit rates. Many of the so-called “low-interest” credit cards available at CreditCards.com carry APRs of 10 to 20 percent, which vary in response to market conditions and your personal credit rating. Even if you stop using your card, the balance that you’ve accumulated will continue to accrue interest until you pay it down in full.
If you’re unable to stop using your card, either because you’re spending more than you take in each month or you’re dealing with a serious life event like unemployment or a costly family medical issue, your balance will continue to grow.
It may be possible to maintain a significant balance on a single credit card by continuing to make meaningful, on-time payments at the end of each billing cycle, but you’ll lose a great deal of money in the process. For instance, a 15 percent APR on an average balance of $5,000 will cost you $750 per year in interest charges alone.
Running balances on multiple cards is more difficult to pull off and greatly increases the chances that you’ll fail to make a payment at some point. If and when you do miss a monthly payment, you’ll begin to accrue penalty interest, which may approach 30 percent annually.
On top of that, your issuer may add various fees and penalties to your account balance. At this point, you’ll find it increasingly difficult to extricate yourself from your spiraling debt situation on your own and may need to enlist the services of a debt settlement agency. Although it may take 24 to 48 months, these debt specialists have a proven track record of settling debt for a fraction of its original value.
There are safer and more effective ways to borrow money than credit cards. So named because they’re protected from default by a tangible asset like a house or vehicle, secured loans generally carry lower rates of interest and require a less-onerous approval process.
In addition to being the biggest loan that you’re ever likely to need, your mortgage may be the most sensible borrowing decision of your life. Rates on traditional 30-year mortgages have settled at historically-low levels during the past few years and show no sign of increasing anytime soon, even as rents remain stubbornly high. In sum, this has created one of the best climates for home-buyers in modern history.
There are a dizzying array of novel mortgage products, many of which are still quite new, so you’ll want to consider your family’s needs before proceeding. If you plan on living in the same house for the foreseeable future, stick with a standard 30-year fixed-rate mortgage. These carry reasonable rates of interest and spread the financial pain of home-ownership across three decades. If you have a long time horizon but would like to save some money on out-year interest, opt for a 15-year fixed-rate loan instead.
If you’re planning on staying in your new home for not more than five to seven years, you may be able to save thousands of dollars with an adjustable-rate mortgage. These loans’ repayment schedules are back-loaded, meaning that their APRs remain fixed at a significant discount to the market rate for the first few years of their term and then spike to “normal” levels until their maturity date.
You can take advantage of an adjustable-rate mortgage in one of two ways: Either pay off as much of your outstanding balance as possible or sell your house outright before the loan’s rates jump. Either way, you’ll come out ahead. On a $100,000 mortgage, for instance, you’ll save $2,000 per year if you can avoid a two percent rate spike. You can find up-to-date rates on all manner of mortgage products at Zillow.com.
Whereas mortgages are a “good” form of credit that enables you to build equity in your home and strengthens your financial reputation, there are also plenty of downright shady ways to borrow money that may end up doing just the opposite.
At some point in your life, you’ve probably been desperate enough to consider taking out a payday loan. These predatory credit products allow you to borrow money against your next paycheck, charging up to 15 percent off the top for the privilege. Since they typically float for two weeks or less, it’s easy to downplay just how expensive this is: Depending on the amount that you borrow, your payday loan may carry an effective APR of 300 to 500 percent.
Payday lenders might let you borrow money when no one else will, but you don’t want their help. If your situation has become so desperate that you’re out of borrowing options, consider contacting a debt settlement agency to shore up the foundation of your financial house.
The quality of a loan is usually inversely proportional to its effective interest rate. For instance, mortgages and student loans represent a tremendous value because they’re cheap and offer favorable repayment terms. In fact, since they’re used to purchase an asset whose value should appreciate over time, both mortgages and student loans are often considered investment vehicles.
Don’t borrow money for its own sake. Any credit facility, even a “quality” product like a mortgage, is a major responsibility and has the potential to hurt your credit if you fail to honor it. Before you take out your next loan, carefully examine its terms and make sure that you can live with them. If you can consistently fulfill your obligations to your creditors, you’ll find it easier to borrow money than ever before.
