Lending Decisions


Introduction | Good vs. Bad Debt | True Cost of Borrowing | Buying a Car | Buying a House | Personal Loans | Pay Day Loans |Review


Introduction

While we can't predict what will happen in our future, we can plan ahead for the unexpected. Financial security is essential to successfully managing major life events, and that means anticipating how unexpected expenses such as a job loss, an injury or the death of a spouse may impact our finances. Sometimes it's necessary to borrow money for major purchases like an education, a car, a house, or maybe even to meet unexpected expenses. Your ability to get a loan generally depends on your credit history, and that depends largely on your track record at repaying what you've borrowed in the past and paying your bills on time. However, over 40% of American families spend more than they earn each year. The average household carries more than $8,000 in credit card debt and personal bankruptcies have double in the past decade.

Flash Card Deck created by Shannon Anderson-Rush with GoConqr

Good Debt vs. Bad Debt

Debt is a concept as intricately intertwined with America these days as baseball, Mom and apple pie. Americans are debtors, not savers, so it's important to understand your debt and learn to manage it. Not all debt is bad nor is all debt good. A mortgage, in most cases, would be considered good debt, whereas putting an expensive meal on a credit card would be considered bad debt. Over the last decade, Americans have been able to access credit too easily. Being able to borrow too much allowed many of us to make bad decisions - decisions that led to painful consequences. Now, the business of lending has changed and the rules of borrowing have changed as well - some, for the better. That is why it is more important than ever to understand how borrowing really works.

Assignment: Good Debt vs. Bad Debt Discussion

Directions: Debt can be a very powerful tool when it is used to build personal wealth. For instance, a low fixed-rate student loan is what we call good debt. Student loan debt is an investment in you and your future and will most likely lead to substantially higher earnings. When debt does not build net worth and is the result of poor spending and budgeting habits - say a flat-screen TV you cannot afford - it's bad debt. Bad debt doesn't build wealth or our earning power - it just saps our financial strength.

You have a conservation with a friend who shares with you: "If I'm taking on debt for a good reason, then it must be "good" debt. "Bad" debt usually occurs when I'm overspending for the wrong reason". How would you respond to your friend about their "debt" attitude? Compose your response in the Good Debt vs. Bad Debt Discussion in itsLearning and then respond to at least two classmates to continue the collaborative discussion.


True Cost of Borrowing

We all know that borrowing any amount of money through any type of lending product puts us into debt. There really isn't any way around it. Typically, debt is considered a "bad thing", and we definitely agree with this, but that doesn't mean that all debt is bad. Deciding whether taking on debt is a good idea or a bad idea should be done on a case by case basis. There is almost always a responsible way to borrow money, no matter what your financial situation is and no matter what type of loan you're interested in. One of the best ways you can figure this out is by taking into consideration the true cost of borrowing.

Borrowing money, whether it's a mortgage or through a credit card, will cost the amount borrowed plus interest. This is a very basic description of being in debt, something that everyone knows and more than likely considers before they decide to be a borrower. But what many borrowers don't realize is that all components of their lending product directly affect how much it will end up costing them. Here are five main factors that affect how much borrowing costs.

true cost of borrowing

The type of loan, credit card, or line of credit chosen will greatly affect the total cost of borrowing. To purchase a house most people need to take out a mortgage, and if you're looking for a short-term financial solution you might turn to a credit card, personal loan, or line of credit. Certain situations in life will require specific loans.

true cost of borrowing

The amount you borrow has a huge impact on the final cost of borrowing. The more you borrow the more you'll need to pay back. However, many borrowers don't take into consideration is that the amount they borrow (principal) can affect all other aspects of the loan. The interest rate, term, and fees are all impacted by the principal.

Borrowing more than you can realistically afford to pay back simply because a bank or lender offers it to you, is the ultimate recipe for out of control debt. Before you decide to accept a loan offer or even before you decide to apply for a loan, you need to carefully consider the amount you're going to borrow and how it will affect your life and the lifestyle that you wish to have.

true cost of borrowing

Most lending products come with their own range of interest rates. The average credit card interest rate is 19.21% and currently, in the United States, a mortgage from a major financial institution will have a rate slightly less than 4%. Please keep in mind that these two examples are generalizations as there are credit cards and mortgages with both significantly higher and lower rates. Hopefully, you get the point though, you're not going to find a credit card with an interest rate of 3%.

When comparing the cost of borrowing, it's important that you not only look at the interest rate but also the annual percentage rate (APR). The APR of a loan is the interest rate plus the cost of any fees averaged out over the length of the loan. It's a great way to determine which loan is not only the least expensive but the best match for you. A lower APR means that your monthly payments will be lower and therefore more affordable.

Choosing Between Fixed and Variable Rate

When you borrow money, you are given an interest rate that is either fixed or variable, it's important to understand how both of these options will affect the overall cost of your loan so that you can make an informed decision about how much you can afford to borrow.

Fixed Rate: When your lending product has a fixed interest rate it means that you'll be given a rate that will remain the same for the duration of your loan. This also means that your monthly payments will always be the same which in turn means that you'll always know what to expect and be able to organize your budget accordingly. Many people choose a fixed rate over a variable rate because it is predictable and stable.

Variable Rate: On the other hand, when the money you borrow comes with a variable rate, it means that your interest rate fluctuates with the benchmark/ overnight interest rate (the interest rate at which banks lend and borrow among themselves). If the overnight interest rate increases, so will your variable interest rate.

To start out, variable interest rates are typically lower than fixed rates, this is often why consumers choose to go with a variable rate. But, should the overnight rate increase, so will your rate which means your monthly payments will become more expensive and potentially harder to maintain. A variable interest rate is hard to predict and therefore less stable than a fixed rate.

true cost of borrowing

A loan term is the period of time in which you must pay back the money you've borrowed plus interest and fees. Loans with longer terms typically have smaller monthly payments, so if cash flow is important to you, a longer term may be beneficial. But, it's important to keep in mind that a longer loan term also means that you'll be paying more in interest over the life of your loan.

true cost of borrowing

The majority of lending products come with fees and penalties, all of which can greatly increase your total cost of borrowing. While there are many fees that simply cannot be avoided, for example, the origination fee for a mortgage, some fees and definitely all penalties can be avoided. This is why it's important that you fully understand all aspect of the product you're interested in before you sign a contract. Sneaky fine print and less than honest lenders are more common than you think and could end up increasing your cost of borrowing by a significant amount and thus take your loan from affordable to unreasonable very quickly.

Borrowing will always cost money, there really isn't a way around it. But the good news is that you are in full control of your money and what you do with it. Taking care of your financial health and managing your finances responsibly should be a top priority of yours. Once you're able to maintain a stable financial life, borrowing becomes easier and more often than not more affordable. Caitlin Wood, LoansCanada


Buying a Car

Most teenagers dream of owning their first car as soon as they turn 16 and have that brand new drivers license. Ready to hit the road? Not so fast.

A car can be more than just your personal transportation. Your set of wheels can improve your quality of life with more ease and convenience, but it's also a major purchase that requires regular maintenance. Because of this, you'll want to choose a car that won't send your budget into overdrive. There are many routes you can take along the way to buying a car. Before you begin shopping, it's helpful to look at your budget and determine how much you can afford to spend on a vehicle.

Car Insurance & Maintenance

As you evaluate your budget for your new vehicle purchase, you must also keep in mind the cost of insurance and maintenance. In the United States, automotive insurance covering liability for injuries and property damage is compulsory in most states, but different states enforce the insurance requirement differently. There are several factors that will affect the cost of insurance including value of the vehicle, your driving history, and the type of insurance. It costs more to insure new automobiles but the cost of maintenance is less in the beginning as opposed to older vehicles which are cheaper to insure but generally cost more to maintain and may need additional repairs. Also new cars come with a warranty where older cars have a very limited warranty if any warranty at all.

Assignment: What is My Best Option for Purchasing a Vehicle Project

Directions: Purchasing a vehicle can greatly affect your financial situation. Through this assignment you will gain a better understanding of the car-buying process and the components that affect your monthly payment. You will compare the purchase of a new car, used car, and a lease. Download the project worksheet from itsLearning and upload when complete.


Buying a House

Some day in the future you are going to be ready to become a home owner. Buying a home may be the largest purchase you'll ever make and the single most important financial decision you will make in your lifetime. However, the process of becoming a first-time homebuyer can be overwhelming, and requires a foundation for basic home-buying knowledge. Before you start house hunting, it's important to understand how owning a home could impact your finances.

Assignment: Question for Thought 9.1

Directions: Roberto and Shelly have been able to save $18,000 for a down payment on a house. Roberto would like to buy a large home that is a long drive from their jobs. Shelly would like a small townhouse near their work. What factors should they consider when buying a home?


Personal Loans

Every year, millions of Americans use personal loans to consolidate debt, pay for unexpected expenses, make home imporvements and more. A personal loan is money borrowed from a bank, credit union or online lender that you pay back in fixed monthly payments, or installments, typically over two to five years. Lender rates can range from 6% to 36% APR. Most personal loans are "unsecured" meaning they are not backed by collateral. A secured loan backed by a car or house is typically cheaper, but you can lose the asset if you default. You usually can use the money for any reason.

Assignment: Where Can I get a Personal Loan article

Directions: Read the article Where Can I get a Personal Loan? and answer the questions in itsLearning.


Pay Day Loans

A payday loan is a small, short-term unsecured loan, "regardless of whether repayment of loans is linked to a borrower's payday." The loans are also sometimes referred to as "cash advances," though that term can also refer to cash provided against a prearranged line of credit such as a credit card.

If you need money fast, you may be tempted by a short-term loan-the kind you plan to pay back quickly. However, whether they're offered by an online payday lender or a check-cashing store in your neighborhood, these loans come with steep costs that can be hard to recover from.

pay day loan

Assignment: Question for Thought 9.2

Directions: 12 million Americans take out payday loans every year, but there are still misconceptions about how they are actually used. Follow the story of Jennifer, a typical payday loan customer, who takes out a cash advance on her paycheck to make ends meet, but ends up paying more than $500 in fees.

Payday loans are marketed as a "quick solution" that is repaid "in just 2 weeks!" Why do you think this marketing strategy is effective? What's dangerous about taking out a payday loan? Submit your reponses to the assignment in itsLearning. Submit directly to the itsLearning textbox.

Assignment: To Borrow or Not to Borrow?

Directions: For this activity, you are taking on the role of a financial planner who is giving advice to three different clients. Each has come to you because he or she is interested in making a major purchase, but none has enough money on hand to buy outright. Each will have to borrow money.

Your job is read about their situations carefully and to write a response for each. Your response should include your advice to each client about whether or not he or she should borrow money for his or her purchase, along with your reasoning. If you do think the client should take out a loan, advise the client on the best places to get a loan and again explain your reasoning. Along with grammar, spelling, and completeness, your work will be assessed on how well you take into account the purpose of the loan, the borrower's level of need, and the borrower's ability to repay the loan. Organize your document by Client 1, Client 2, and Client 3. The scenarios are listed in the assignment in itsLearning.


Review

Download the Lending Decisions Review to help you prepare for the unit assessment. This is not a graded assignment.

Resources

If you are having problems viewing this page, opening videos, or accessing the URLs, the direct links are posted below. All assignments are submitted in itsLearning. If you have having problems, contact Mrs. Rush through the itsLearning email client.

Where to get a Personal Loan: https://www.nerdwallet.com/blog/loans/personal-loan-bank-credit-union/


Credits


Transcript of this lesson