Thanks to the more flexible lending policy and an increased borrowing capacity people now can find easy access to lots of different sources to borrow money. However, easy as it may seem, there are lots of things to consider before you borrow so s to make your loan a useful one.
It is essential that you know exactly how a loan works and the cost of borrowing so that you do not end up in a debt trap down the road. It is for this reason you are suggested that you always consult with a loan advisor before you take out any loan, whether it is form any conventional bank or non-bank financial organization and even from any online money lending sources such as https://libertylending.com or any other.
It is important to know how a loan works when you borrow money because if you have a better understanding of loans you will be able to:
- Save money in the process
- Know the pros and cons
- Make better decisions about the debt
- Know when to it and
- Avoid the hassles while borrowing.
Borrowing money will come with a cost. This is in keeping with the concept of borrowing which says that if you want to get money all it takes is more money. This means that when you borrow a certain sum of money you will not only have to repay the amount that you borrowed but will also have to pay and additional amount to the money lender or creditor.
This extra amount is termed as interest in the finance world which is actually the income of the creditor and your monetary gratitude to the creditor for allowing you to use their money sacrificing their scope of using it themselves. In addition to that you may also have to pay a few specific fees when you borrow money.
The cost of borrowing
The cost of the loan is the key part and you will need to understand this aspect first if you want to know how loans work. This knowledge will also help you to choose the right type of loan according to your need and affordability to repay it on time with interest predetermined on it.
In general, when you take out a loan it is prudent to minimize the cost of it but these costs are not always easy to understand and therefore you do not know which one to minimize. Typically, the money lenders will not show you exactly how the loans work and what are the costs involved in it. Therefore, you will be better off if you run the numbers yourself.
Typically, the cost of a loan will have different names and forms. These are
- Interest:As mentioned earlier, this is the amount that you pay in addition to the principal amount for the privilege of using the money of someone else. In credit card loans this rate of interest is the highest and can go as high as 25 to 30% depending on the type of the card.
- Fees: Fees also can come in different names and forms such as loan origination or processing fees, annual fees, fees for late payments, foreclosure fees, early loan termination fees, transfer fees and much more.
- Finance charges: These are the charges that include all fees and interest added together. This amount is expressed as an Annual Percentage Rate or APR.
Out of all these, the APR calculation is the most important factor as that will determine the final amount that you will have to pay when you borrow a certain amount of money. Usually, the money lender will use specific calculator to evaluate the Annual Percentage Rate.
This is actually a yearly figurebut the interest is not charged on a yearly basis. In fact, the APR can be charged on a daily basis and it entirely depends on the type of the loan as well as the lending policy of the company offering you credit. However, the money lender is legally obligated to disclose this APR to you while you borrow the money.
Calculating the APR
It will be helpful for you to understand whether or not the lender is charging the actual amount if you yourself know how to calculate the APR and your interest.
Here are the simple steps to calculate the rate of interest one you know the Annual Percentage Rate:
- First, look at the loan agreement for the number of days
- Second, divide the APR by 360 or 365 days as mentioned in the agreement.
This will give you the periodic interest rate. Typically, this is the rate that will be compounded with your principal loan amount every day! Yes, every day.
- Every time the interest amount is calculated as a percentage of the total amount borrowed and added to it, it actually becomes a part of the new outstanding balance.
- Next time when the interest will be calculated, it will be done on the increased amount.
- This goes on, and on, and on till you repay your loan completely.
If you default in making a couple of payments or fall back with your repayment schedule the late payment fees and others will also get added and interests on it will be calculated and added. This will inflate your outstanding balance even further.
This is how loan works and the interest amount keeps on building on itself and accumulating with your outstanding loan amount. This is the magic of “compound” interest. See how the money lenders make money!
In most of the cases, it is the fundamental Loan Amortization Calculator that will be used to make the loans work. You can see how it affects your loan balance by using a spreadsheet and play with the numbers. You will yourself see what exactly happens when you change a few specific variables.
Therefore, cost of a loan can be really tricky and put your finance in jeopardy. It is for this reason you must be very sure about the rate of interest of your loan along with the transaction fees so as to know better how a loan works.