Loan Basics For Students
There is a lot of unique vocabulary related to loans. Let’s go over some terms you need to understand about loan basics for student when trying to secure a loan.
Need to Know Vocabulary
Principal: The principal is the original amount you borrow. For example, if you take out a $10,000 loan, that $10,000 is the principal. As you repay the loan, you’ll be paying back both the principal and the interest.
Interest Rate: Interest is essentially the cost of borrowing money. It’s usually expressed as an annual percentage rate (APR). There are two main types of interest rates:
- Fixed rates: These remain constant throughout the loan term.
- Variable rates: These can fluctuate (go up or down) based on market conditions.
Understanding how interest compounds (daily, monthly, or annually) can help you grasp the true cost of your loan over time.
Loan Term: The loan term is the period over which you agree to repay the loan. Longer terms usually mean lower monthly payments but more interest paid overall. Shorter terms often have higher monthly payments but less total interest.
Monthly Payment: Your monthly payment is calculated based on the principal, interest rate, and loan term. It’s important to ensure this payment fits comfortably within your budget before taking out a loan.
Collateral: For secured loans, collateral is an asset you pledge to the lender. If you default on the loan, the lender can seize this asset. Common forms of collateral include:
- Homes (for mortgages)
- Vehicles (for auto loans)
- Savings accounts or certificates of deposit (for secured personal loans)
Types of Loans
Now that you know the basic terminology of a loan, let’s dive into the different kinds of loans you may encounter as a student.
Personal Loans:
Personal loans are unsecured loans that can be used for a variety of reasons, such as debt consolidation, medical expenses, or major purchases. The loan amount typically ranges from $1,000 to $50,000, with some lenders offering up to $100,000. Interest rates can vary based on your credit score, ranging from around 6% to 36%. Repayment terms usually span from 1 to 7 years.
Student Loans:
Student loans are specifically designed to cover educational expenses, including tuition, books, and living costs. They can be either federal or private:
- Federal student loans are provided by the government and often have lower interest rates and more flexible repayment options.
- Private student loans are offered by banks, credit unions, and other private lenders. They typically have higher interest rates and fewer repayment options compared to federal loans4.
Auto Loans:
Auto loans are used to finance the purchase of a vehicle. These loans are typically secured by the car itself, meaning the lender can repossess the vehicle if you fail to make payments.
Credit Cards:
Credit cards provide a form of revolving credit that can be used for everyday purchases, emergencies, or short-term borrowing. They come with a credit limit, which is the maximum amount you can borrow at any given time. Credit cards often have higher interest rates compared to other types of loans, but you only pay interest if you carry a balance month-to-month. They can also offer rewards, such as cash back, travel points, or other perks.
How Loans Impact Your Credit Score:
There are many ways a loan can impact your credit score, both positively and negatively. When you apply for a loan, the hard credit check may temporarily lower your score. However, making timely payments can improve your score over time, while late or missed payments can severely damage it. Successfully paying off a loan can also boost your credit score, reflecting positively on your credit history.
Understanding loans is a crucial part of financial literacy. By understanding these concepts, you’ll be better equipped to make informed decisions about borrowing money.
Remember, while loans can be useful tools, they come with responsibilities. Consider your future financial health before taking out a loan. Don’t hesitate to seek assistance from financial professionals if you have any doubts.
- Previous
- Signing A New Contract Checklist