Reference no: EM132091118

It is important to understand the costs associated with loans.

These include the principle amount, interest, "fees" and discounts:

The principle about is the amount that you borrow (want/need) and will pay back.

Interest is the periodic (daily/monthly/annual) amount charged to borrow/rent the money.

The "fees" come in many varieties and include a fixed fee to borrow, transaction cost, other lender costs, other fees and penalties.

Discounts are money the lender gives you for using their service.

Examples:

1) When buying on your credit card, you purchase an item for $5,000:

If you repay the full amount by the due date, your cost is $5,000 and the credit card company may actually give you a discount in the form of cash back or "points." That means that you have spent less than the full amount.

If you are late or you pay the minimum over time, or miss a payment, etc. the company will charge you interest and fees. Interest is accumulated daily on the entire outstanding amount. These cost can accumulate very quickly.

2) When you borrow $5000 from your credit card company or from a short-term loan company ("payday"/"title" loan, etc.) or overdraw when using your debit card.

You are required to repay the full principle on or before the due date.

You will be required to pay a minimum or a percentage fee. e.g. at 3% = $150. In the case of a debit card overdraft, the overdraft fee is per transaction and can be more than the transaction.

You will also be required to pay interest on the full loan amount (principle and interest).

If you are late, you will also have to pay additional fees.

3) Car loans and Mortgages work very much like short-term loans and include a variety of fees: points, closing cost, loan origination, inspection, title company fees, document currier, credit checks... the difference is that when stretched out over time, these add up to much less when considered as a percentage of the loan.

You can see that fees can quickly add up. In many cases, the fees for a short-term loan will be much more than the interest. A line of credit is similar, but is a more controlled way to borrow.

Borrowing from yourself is another alternative, but the money is then no longer invested and earning you a return. The above my simplified way of explaining this. Managing your loan costs important.

IN 200 WORDS OR MORE

What are some examples that you have seen of positive and negative loans?

What are the best ways to avoid fees?