Lending and Credit Basics

Borrowing money via loans and using credit are common financial practices.

 

Not only can lending and using credit help you gain financial stability but they can also be great methods for improving your financial status. Therefore, you should understand the basics of lending and credit usage that may affect your finances to prevent future economic problems. While lending money and using credit cards are only a part of managing your finances, they are essential procedures that must be handled carefully. By learning what lending and using credit do, you can better prepare yourself for occasions in which you may have to request loans or reduce your credit debt.

What is lending?

Lending, at its most basic level, is the temporary exchange of funding from one entity to another. All money loaned is expected to be returned, but interest payments made on the loan that accrue until the entire loan is repaid may make the loan more expensive. Entities involved in the monetary exchange may be corporations or individuals, depending on the purpose and size of the loan. Whereas credit card charges can be made at any time for daily expenses, personal loans lend you fixed amounts of money to help pay for expensive goods or services such as college tuition.

Often, lenders distribute loans to individuals and determine factors such as the interest rate, length and type of the loan. Lenders may be banks, credit unions and other financial institutions. However, peer-to-peer lending and crowdfunding through online organizations are becoming more common. Because of its broad meaning, the term “lending” can ever refer to the fiscal transactions between friends and family members – also known as private party loans – or personal loans from yourself to your business, for instance, as an alternative to investing. Before agreeing to a loan, you should be familiar with the lender(s) and ensure that you are satisfied with the conditions of the loan. Understanding basic lending and credit terms can help you make smart financial decisions.

Loans typically abide by state and federal guidelines to eliminate the threat of excessive interest rates and unfair conditions. This protects you from many predatory loan offers, but you must still be careful when choosing a loan. The total cost of loans is often difficult to calculate, considering you must include the cost of each installment, taxes and interest fees as well as the down payment. Lenders use your debt-to-income ratio to help determine payment amounts and your ability to make those payments each month. To assess your eligibility for and the cost of a loan, lenders may request the following information:

  • Proof of your income
  • Your credit history
  • Your employment history
  • Your debt
  • Your assets

There are numerous types of loans for which you may qualify, and they are defined by their intended uses. A list of the common types of loans is provided below:

  • Student loans
  • Mortgages
  • Auto loans
  • Small business loans
  • Personal loans

All these types of loans are considered close-ended loans. This means that they cannot be borrowed from again without reapproval. However, secured and collateral loans are connected to your personal property, such as in the case of home equity loans, and may be utilized multiple times. Still, all loans have penalties for missing payments. The reason you may require loans determines the type of loan you may need and from whom you must request the loan.

Safe Lending Practices

To guarantee that you receive the best and safest loan option, you should do your research. You are encouraged to shop around for different loan offers prior to settling on one. Additionally, you should fully review your loan agreement and ask questions if you are unsure of any details. Knowing what influences annual percentage rates and loan costs can help you determine whether a loan offer is reasonable or not. You should negotiate the loan terms with your lender in light of your financial information. Getting all the parameters of the loan in print can be beneficial if your lender tries to argue for higher rates or dispute the agreement, and you will be able to retain a copy of the loan agreement for your personal records.

 

What is credit?

While taking loans and using credit both involve borrowing money to make purchases, credit enables you to borrow money at any time. However, you cannot exceed your predetermined credit limit. You receive credit from a credit grantor after passing a basic application process. Credit grantors may consult your income, employment history and current assets to determine your eligibility for certain types of credit. A list of the types of credit you may receive is as follows:

  • Revolving credit: Credit in which you receive a card with a maximum credit limit. You retain a credit balance for each month and must make regular payments. Most credit cards are classified as revolving credit.
  • Charge cards: Charge cards also have maximum credit limits, but, each month, you must pay the total balance on the card rather than partial amounts.
  • Service credit: Some service accounts you have (e.g., cell phone service) are included in your credit history. Therefore, your payment status with service companies can affect your overall credit.
  • Installment credit: This credit involves fixed loans that have varying repayment periods, such as a car loan. If you cannot regularly pay installments, then your credit score may diminish.

Because credit gives you the opportunity to buy items without worrying about immediately repaying the funds, some credit users may face the temptation of overusing their credit cards without paying their bills regularly. When used responsibly, though, credit plays an important role in the achievement of your financial goals. For instance, your credit history is considered when you apply for loans. If you have lower credit and a lot of debt, you may receive higher loan costs. Your credit history is also evaluated when you are trying to buy a house or a vehicle and when you are applying for certain jobs, so you should try to maintain good credit. When looking for a credit card, keep in mind that you have options of unsecured and secured credit cards. A secured card needs a cash deposit, and the limit of this card usually matches up with your deposit. You eventually get this deposit back if you make on-time payments. Unsecured cards are the typical type of credit card that does not require a deposit, but you must have an acceptable credit score for the card company to receive this type of card.

How to Maintain Good Credit

To maintain good credit or improve your existing credit rating, you should pay all your bills on time, keep in contact with your creditors and pay off debt when possible. You can check your credit rating online by requesting a free copy of your credit report to stay informed on your credit history. Here are a few suggestions for you to keep in mind when managing your credit:

  • Set up payment reminders through your bank or on your phone to help you remember when bills are due.
  • Pay late payments to stop incurring late fees and penalties.
  • Contact certified credit counselors if you are having difficulties managing your credit.

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