Things You Really Need to Know Before Borrowing Money

Dealing with debt is no fun, so it’s understandable that many of us avoid borrowing money, but borrowing isn’t always bad. In fact, it’s a part of life for most Americans, and also necessary to a healthy economy.

While borrowing can potentially result in problematic debt, that’s not the case for everyone. Almost 70% of Americans surveyed about borrowing money claimed that their borrowing ultimately improved their life, but that’s largely due to knowing exactly what they were doing in the first place. If you’re thinking of borrowing money, for any reason, it’s vital that you understand a few things first.

How Do Credit Scores Really Work?

Your credit score is simply a number that indicates to lenders whether you’re a good borrower or not, from the lender’s point of view. So it’s more about your ability to pay your debt back than how much debt you’re in, how long it will take you to pay it back, or even whether you can truly afford it.

In fact, a ‘good borrower’ (again, from the lenders point of view) is arguably one who stays in debt, but keeps paying the money back, with interest. Never forget that lenders make their money from the interest they charge you, so a customer who never defaults, but constantly re-finances and keeps paying that interest, is a good customer.

Your credit score is based on your credit history, which includes information like the number of accounts you hold, your total level of debt, your credit utilization rate, repayment history, and various other factors. Having a lot of debt doesn’t necessarily mean your score is bad. If you’ve always made every payment on time it could be very good. So check your credit score online and keep track of it on a regular basis.

Using credit can actually help your credit score over time, but don’t use that as an excuse to take on debt for the sake of it. There are plenty of ways to build a good credit score without purposely running up unnecessary debt. Take steps to proactively build your score such as regularly using (and paying off) a credit card, and ensuring that you make all loan and other payments on time. Schedule automatic payments if you think you’ll forget.

Something that can negatively impact your score is missing payments, so it’s vital to ensure that you can, at the very least, make the minimum payment (or fixed payment, on a loan that’s paid back at a fixed amount each month).

Another thing that negatively impacts your score is taking out new credit agreements. For this reason, it’s vital to check if you’re pre-approved or pre-qualified for any new card or loan that you’re considering.

Why Is Consumer Credit So Expensive?

Consumer credit such as credit cards and store charge cards is one of the most expensive forms of credit there is. Credit cards can have a ridiculously high APR, and a lot of fine print.

For example, many people like to use their credit cards to take advantage of the interest free ‘grace period’ but with most cards you’ll find that this only applies to those paying off their credit card every month. Once you start carrying a rolling balance, your interest free period can disappear.

People also often use credit cards to take advantage of a 0% balance transfer or deal. Done correctly, this can be a good way to access interest-free credit, but again check the small print. If you miss a payment on a 0% card, even by one day, you’ll often find there’s a late fee and you lose your 0% rate permanently (often to be replaced with a higher-than-average APR).

In short, even if you’re trying to use credit cards ‘the right way’ it’s easy to make a small mistake and start stacking up interest rates you didn’t plan for. You don’t necessarily need to avoid credit cards (there are some big advantages attached to them). Just be really sure you understand all the implications, have read all the small print, and know exactly what you have to do to avoid any extra charges.

Can I Get an Unsecured Loan?

A lot of loans are secured against an asset, such as a house or a car, which is why your house or car can be repossessed if you stop paying your mortgage or car finance payments.

An unsecured loan is simply based on a contract where you agree to repay the lender at a set rate. If you miss payments they can impose a late fee and, if they choose, could ultimately take legal action against you to recover the money owed, but they cannot take your home or other possessions in lieu of the money owed.

Unsecured loans sound good, but come with some drawbacks too. As there’s no collateral involved, you’ll often need a very good credit score, and interest rates will be higher than on a secured loan such as a mortgage.

It’s vital to assess all the pros and cons of an unsecured loan and make sure you’ll be able to make the repayments for the entire term of the loan. There’s often very little flexibility with payments, as you’ll be paying a fixed amount each month, as opposed to say credit card debt, where you can pay any amount (above the minimum payment of course). Interest on an unsecured loan with a reputable lender, however, will be lower than on a credit card.

If in doubt, see if you can speak to a credit counselor. They’re often a very affordable form of financial advice.

Where Is the Best Place to Borrow Money From?

The best option if you need to borrow money is often a financial institution you already have a relationship with, such as your bank. If you have a good credit score and a history with them you’ll often get a better deal than with a lender you’ve never dealt with before. However this isn’t always the case so it can pay to shop around and compare different lenders.

If another reputable lender is offering a better deal or lower interest rates, you can always mention this to your own bank. They may be able to match that deal if they think you’re reliable and really want to keep your business.

You could also consider direct-from-provider credit. Some consumer focused outlets, from car dealerships to department stores, offer low interest, and sometimes no-interest finance, usually over a short time period such as 12 months.

Just be aware that, as with 0% credit card deals, if you don’t make the minimum payments the deal disappears, often to be replaced with a much higher interest rate.

Can My Lender Help Me if I Can’t Pay?

In most cases, yes. The very first thing to do if you can’t pay, or are struggling to make payments, is always to talk to your lender. They may be able to extend your payment deadline, offer you a payment holiday, or restructure your loan.

Responsible lenders would invariably rather get slightly lower payments for example, perhaps spread over a longer amount a time, than have you default on the loan. Adapting and restructuring loans is a normal part of business for most lenders and they’ll often be happy to work something out with you in person or over the phone.

Just remember, there’s a reason they’re often happy to help you out. Re-structuring a loan usually means you’ll be taking longer to pay it off, and therefore paying more interest overall. If you can avoid this, that’s obviously more desirable.

Ultimately, it’s not necessarily borrowing money that gets you in trouble. It’s not understanding all the nuances of your loan or credit agreement. If you’re one of the many Americans looking at this option, take the time to make sure you know exactly what you’re getting into.

Karen Banes is a freelance writer specializing in entrepreneurship, parenting and lifestyle. She writes articles, website content, ebooks and the occasional award winning short story. Her work has appeared in a range of publications both online and off, including The Washington Post, Life Info Magazine, Transitions Abroad, Brave New Traveler, Natural Parenting Group, and Copia Magazine. Learn More About Karen