Southland News

April is Financial Literacy Month, so we're going to take you through the basics of five financial principles:

• Earning
• Saving and investing
• Protecting
• Spending
• Borrowing

Follow along each week to learn some key information about each topic!

Principle 5: Borrowing

Borrowing money, or debt, is inevitable for most people. Whether it's student loans, credit card debt or a mortgage, you are likely going to have multiple debts throughout your lifetime,  so it's important to understand how debt works and manage it responsibly.

You should know these things before borrowing any money:

1. What type of debt is it?
2. What type of interest?
3. What is the interest rate?
4. What is the principal?
5. What is the term?

Types of debt

• Secure: Secured debt is when the borrower puts up an asset as collateral for the loan. If there is a default on the loan, then the lender can then collect the asset that was set as collateral. This is common in mortgages and auto loans, as the home or the vehicle would be set as the collateral.
• Unsecure: Unsecured loans have no collateral backing, so these loans are a little harder to be approved for and the interest rates are typically higher. 
• Revolving: Revolving debt is a type of debt with a revolving line of credit like credit cards or home equity line of credits. Let's take your credit card for example. If your credit limit is $10,000, and you have an unpaid balance of $500, then your new available balance is $9,500. Then when you pay back the $500 and any interest you may have accrued, your credit line is once again $10,000.

Types of interest

• Variable: Variable interest means that the interest charged on the outstanding balance can change as the market changes, so your payment amount will fluctuate.
• Fixed: Fixed interest means that the interest amount will stay the same for the entire term of the loan, and so your payment will also stay the same. 
• Simple: Simple interest is a method in which interest owed on a loan is calculated. It is calculated by multiplying the current principal amount by the interest rate. This means that as you make payments, your principal amount decreases, which also decreases the amount of interest you are charged.
• Compound: Compound interest is another method in which interest owed is calculated. With compound interest, you are accruing interest on both your unpaid principal and your unpaid interest. 

Interest rate

Your interest rate, which is commonly referred to as your APR, is the yearly interest that's charged to you as the borrower.

The lower your interest rate, the lower the amount that you pay over the life of your loan will be.

Principal

The loan principal is the initial amount taken out as a loan, not including interest.

When you make payments on a loan, most of that payment will go towards paying interest owed, and the rest of the payment will go towards paying down your principal amount.

Term

A loan term is the length of the loan, or the amount of time that it will take for the loan to be paid off when scheduled payments are followed. You can usually select your own term length, whether that is a few months or 15 years. 

The loan should be fully paid or refinanced before the term of the loan is up. Your loan terms should also describe how prepayments work, and if you will be assessed any penalties for making extra payments or larger payments than initially agreed to. 

The length of your loan will determine things like your monthly payment cost, interest rates, and how much interest is accrued throughout the life of the loan. 

Understanding your debt is key

Being able to understand your current debts and analyze any future loans is the key to managing your debt wisely. Not understanding your loan terms and interest rates can cause you to pay thousands of dollars in interest to your lender if you aren't paying attention. 

Debt doesn't need to be scary as long as you have a plan to pay it down and manage it wisely. Make your debt work for you!