Financial Pillar IV: Loans

I remember that one kid from my high school lunch table who would always ask the question: “Can I borrow a dollar?”.  Whether it was for the purchase of a bag of chips, cookies, or ice cream, everyone at the table knew that there would be no repayment of that dollar. While such small amounts of money can sometimes be forgiven and forgotten amongst friends, we must come to the realization that this is the exception to the rule. In the real world, you must repay whatever you owe.

People borrow money for many reasons. Some for education, others for business, a new car, a home, to travel, an emergency, or even to pay off other debt.  There are various types of loans:

  1. Open ended loans- dynamic and revolving loans such as a credit card
  2. Closed-ended loans-  a one-time request like a car loan.
  3. Secured loans- a loan that requires an asset to be collateral (something pledged as security for repayment of a loan, to be forfeited in the event of a default) should the borrower be unable to repay the debt.
  4. Unsecured loan- the opposite of a secured loan as there is no asset tied to the debt as collateral. These loans often come with higher interest rates.
  5. Conventional loans- these are mortgage loans that are not connected to any government agency.
  6. Conforming loans- mortgage loans that conform to GSE (Government-Sponsored Enterprise) guidelines; the chief guideline being the maximum loan amount.
  7. Non-conforming loans- mortgage loans that do not conform to GSE guidelines

Many Americans are affected by loans connected to their education. Student Loan Hero, Inc. reports that there are over 44 million borrowers and the graduate class of 2016 has $37,172 in average debt. From 2004 to 2015, student loan debt has increased 256% nationwide to nearly $1.3 trillion dollars.  See the graph below on this loan epidemic:

Essentially everyone will have to borrow money at some point in their lives. Borrowing is not necessarily a bad thing. The way we manage the amount we borrow and how we repay it is what often leads to trouble. A major item some may not always consider is interest, which is the additional cost you pay for borrowing money. Interest is always in addition to the repayment of the original loan and therefore a Clever African will always search for the lowest interest rates when borrowing.  Let’s look at a couple examples where high-interest rates were able to bankrupt millionaires.

  1. Former athlete Eddy Curry could not repay a $570,000 five month personal loan – with an 85%interest rate!!—court documents cite excuses such as his $1,000/mo cable bill
  2. Former athlete Vince Young signed a $58 million contract, but a temporary work stoppage caused him to secure a $2 million loan @ 20% interest (partly to pay bills and partly to throw himself a 300,000 birthday party) – he later filed for bankruptcy.

Many of us may not be in a position to obtain a million dollar loan. Although the dollar amount of debt may be different in your life than in the examples above, the concept remains the same. Consider the following illustration when it comes to student loans.

Frank has a student loan of 10k with a 7% interest rate for 10 years. He decided to refinance his loan and received a 5% fixed rate for 10 years. By simply shopping around for a lower rate, Frank was able to save about $1,200 by reducing his interest rate.

The graph above gives a representation of the many Americans that are in debt. We must remember that debt is almost inevitable and we must learn how to minimize and manage it properly. We must always strive to reach a point in life where we can live debt free. That life of freedom does not happen by accident; it starts with a commitment to your budget and expense management and it continues with creating a plan for the repayment of your loans.

Take a look at the student loan calculator we have provided to figure out just how much you will be paying for student loans. Download and use this excel template from Excely to figure out the details of all your personal loans. Once you have all the data in one place, you can make more informed decisions as to which loans to attack first and what type of repayment plan you should develop for yourself.

We encourage you to leave comments below on any thoughts relating to this post.  If you have private suggestions or feedback, feel free to send us a message.




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