Essentials of Debt
When you borrow money, you are responsible for paying not only the amount borrowed, but also fees and interest. In order to estimate how much you will pay in total for borrowing money, you should consider the following costs.
If you are working with a lender, they should be able to answer questions about when and how you’ll pay for these costs, especially if it’s for a large loan for a car or a house. Your lender works for you—you are paying them! Ask them questions. Chances are they’ll want to provide you with all the information they can to make it more likely you'll borrow from them.
Fees are miscellaneous charges from the lender that can be levied against your account. These fees could be added to the balance of your loan or credit card bill, deducted from the disbursed loan funds, or requested up-front, before you can access your funds.
Here are some common examples of fees:
Origination fees: the cost of processing your loan
Early payment fees: for paying off a loan early
Annual fees: for having a specific credit card each year
Cash advance fees: for using your credit card to take cash from an ATM
Balance transfer fees: for transferring a balance from one card to another
Late payment fees: for paying your bill late
Over-the-limit fees: for spending over your credit limit
Down payments and closing costs for a house or car are also types of fees.
In addition to fees, interest accrues on your owed balance. Interest can be simple or can compound. To understand simple and compound interest, watch the video below.
Debt exists in two common forms:
With revolving debt, you can borrow up to a credit limit, and continue borrowing up to that limit monthly so long as you pay the balance you owe.
Credit cards are an example of revolving debt. Credit cards allow you to access a line of credit to make purchases, then pay the balance accrued at the end of the billing cycle. This is different from a debit card because instead of deducting purchases from your bank account automatically in real time, the card issuer pays for your purchases and you repay the issuer.
With installment debt, you borrow one lump sum and pay it back in regular amounts and time intervals.
Loans are an example of installment debt. This includes student loans, mortgages, auto loans, and more.
Here are some key terms and concepts you should understand before you decide to borrow.
APR combines the cost of loan fees with the interest accrued, providing you with the most accurate estimate of how much your loan will cost. APR can be helpful in comparing different loan options.
The amount you pay to the lender in addition to the principal.
The individual or entity from whom you borrow money.
The binding legal document that outlines the terms of your loan agreement. You are required to sign your MPN before your borrowed funds are disbursed to you.
The amount of time you have to pay off your balance without incurring the costs of borrowing.
The amount borrowed from the lender.
The time period in which you are expected to complete repayment of the loan, as agreed upon by the lender and the borrower.