There’s a high chance you’ll encounter loans at some point in your life. Whether it’s a student loan, a mortgage loan, or even a personal loan, there might be a time where you consider getting one. Honestly, everyone should acquire knowledge of loans as they’re a key part of your finances. So many of us don’t actually understand what they are and how they work. As such, you see lots of mixed opinions on them, with some people saying loans are terrible, while others say they’re a helpful financial tool.
The reality is that they can be good and bad – and you’ll understand how this is the case when you learn more about loans. As luck would have it, that’s exactly what you’ll be doing today! Keep reading, and you’ll find lots of information and savvy tips on financial loans…
What is a loan?
A loan is basically a financial transaction where you borrow money from a lender, under the stipulation that you pay them back. At its core, that’s pretty much all you need to know about what a loan is. It’s simply the borrowing of money from one entity to another.
How do loans work?
Of course, the previous explanation glosses over some key aspects of loans. Mainly, how do they work? If lenders just give people money for a living, what do they gain out of it? How do they actually make money from handing out loans?
Typically, there are a couple of ways that lenders earn a living. They may add fees onto your loan – like admin charges, etc. – and they use interest rates. An interest rate is the main way that lenders make money, basically charging you for borrowing money. It’s given as a percentage, which is then taken out of your loan and added onto your repayments. So, let’s say the interest rate is 1%, you will be charged 1% of your loan on top of what you owe. Basically, it’s a guaranteed way for them to make money.
So, interest rates and any extra fees are crucial as they pretty much tell you how much the loan will cost. This is where lots of people slip up, not realising how expensive a loan will actually be.
When are loans good?
Loans tend to be good when they help you pay for something important. The best examples of this are student loans, mortgage loans, business loans, and so on. In each of these scenarios, you borrow money to afford something that you couldn’t get by yourself. Not only that but the things you purchase with the loan yield long-term benefits. This is sometimes known as being in good debt!
Loans are also good when the payment terms are in your favor. Effectively, you may have flexible repayment terms that let you choose when to make payments and how much money to repay. You may also have a reasonable interest rate and no extra fees to worry about. You’ll also be given a decent amount of time to repay the loan before you’re hit with extra charges and penalty fees.
A lot of this depends on your own financial situation. Some people can afford to pay more than others, meaning certain loans might be better for them. This is why loan comparison is always important so you find loans that align with your finances and allow you to pay what you owe on a schedule that suits your life. The ideal loan is one that you rarely have to think about – you set up monthly repayments by direct debit, then get on with your life as the debt is repaid.
When are loans bad?
A bad loan is usually one that’s riddled with hidden fees, penalty charges, and an extortionate interest rate. Commonly, all short-term loans fall into this category – also called payday loans. With loans like this, you’re often given money, but you have to repay it all within a few days or weeks. If you don’t, you get hit with huge fees that make the loan cost ten times what you actually borrowed.
These loans prey on the financially unstable, promising you an answer to your problems. For example, you can’t pay your bills this month, so you get a short-term loan to help you out. Then, you can’t repay the loan, so you end up in a worse situation. As a general rule, avoid any short-term loans and opt for ones that are focused on long-term repayments and gains.
Hopefully, this explains loans in a decent amount of detail for the average person to take in. They can be good, but only when the interest rates and payment terms are favourable. Similarly, only take out a loan when you absolutely need to, preferably if it helps you access something that yields long-term benefits.