Loans and Credit

Introduction

Loans can spread the cost of big purchases, but they must be repaid with interest. Systems for credit scoring and consumer protection differ widely by country, so this lesson explains the general ideas. Check your national rules and official consumer guidance.

Compare by total cost

A lender may highlight a low monthly payment. Always ask for:

• The interest rate and APR (or the local equivalent for total cost)
• The term (how long)
• Fees: arrangement, late payment, early repayment
• The total amount you will repay

Example: borrowing 10,000 at 6 percent a year.

A longer term lowers the payment but costs more in total. (The 60-month figures follow the standard loan formula, and you can check them in a spreadsheet with the PMT function.)

Loan features

• Fixed rate: the rate stays the same for a set period, so payments are predictable.
• Variable rate: the rate can change, so payments can rise or fall. Check what happens if rates rise.
• Secured loan: backed by an asset, such as a home or car. The lender can take it if you do not repay. Rates are often lower, but the risk is greater.
• Unsecured loan: no asset is pledged. Rates are often higher.
• Revolving credit (credit cards): you can borrow repeatedly up to a limit, and pay interest on unpaid balances.
• Instalment loans: fixed payments for a set term.

Affordability

Before borrowing, check that you can repay even if something goes wrong. A cautious approach is to test the payment against your budget with a lower income. Avoid borrowing to cover everyday spending. If you need to borrow often just to make ends meet, seek free advice.

Credit history

In many countries, lenders use credit reports and scores built from your borrowing and repayment history to decide whether to lend and at what rate. Names and methods differ. General habits that tend to help:

• Pay on time. Late payments are damaging.
• Keep balances low relative to limits.
• Avoid many credit applications in a short time.
• Check your credit report regularly with the official providers in your country, and correct errors. Be careful of paid services you do not need.
• Keep old accounts in good standing where sensible.
• Understand that having no history can also make borrowing harder.

Read the contract

Before signing, check cooling-off rights, early repayment terms, penalties and what happens if you miss payments. Ask questions. If someone pressures you, step back.

Try it yourself

Use a spreadsheet PMT function to compare a 10,000 loan at 6 percent over 36, 48 and 60 months. List the monthly payment, total repaid and interest for each.

Summary

• Compare loans by APR, fees and total repaid, not just the monthly payment.
• Know the difference between fixed and variable rates, and between secured and unsecured loans.
• Borrow only what you can repay, and protect your credit history.