We are wrapping up our discussion on DEBTS during Money March with Personal Loans and Home loans. If you missed any earlier discussions, check out the following links: WAYS TO TRACK EXPENSES, WHY YOU SHOULD TRACK EXPENSES, HOW TO START SAVING MONEY, SINKING FUNDS, WHAT IS YOUR MONEY PERSONALITY, DEBTS-CREDIT CARDS, and DEBTS-STUDENT LOANS AND AUTO LOANS.
Debts come in all shapes and sizes, and as you have probably already seen, we all think we need debts for different reasons. Whether it is to get a reliable vehicle or go on a trip with our friends, buying our first home or going to college, it is really hard NOT to go into debt. There are different financial schools of thought about debt and whether you should have debt ranging from trying to live your life completely debt free to using debt for building your credit score. The one thing that all of these different systems agree on is not allowing yourself to be consumed by your debt.
The next types of loans that I will be addressing, personal lines of credit and mortgages, are very different types of loans. While you may need to get a mortgage to get a home, you may not need to ever get a personal loan. Here is a list of the pros and cons of each type, so that you can make better decisions for yourself.
Mortgages, or home loans, work differently than other types of loans and are usually much harder to get. The typical mortgage lasts for 15 or 30 years and can have different types of interest applied to them, fixed or variable. It can take months to get qualified for a home mortgage, as the bank delves into every aspect of your financial life and credit score, making sure you will be able to make your payments for such a long period of time. You are typically required to have at least 10% of the cost of the house available as a down payment plus closing costs, points, the cost of inspections and appraisals, etc. Some mortgages, such as Veteran programs, will require you to make sure the house meets certain requirements, like hand rails or waterproofing the basement, which the seller may ask you to pay for before the house can even be yours. There is a lot of negotiating when it comes to home ownership! Let’s look at the specific pros and cons:
- It is a “necessary debt.” Most will agree that having a mortgage is necessary for home ownership and that the benefits far outweigh the risks. This is because it is such a long term investment and your home can grow in value over time based on the economy. Many people buy properties to rent out and make income off of, because owning property is such a good investment.
- Affordability. Homes costs a lot of money these days. Spreading out the cost of your home for 15 or 30 years will allow you to afford a nice home. Also, because it usually gains in value, you can easily upgrade to another home after a few years by making a profit off the sale of your current home.
- Lots of financial options. With a mortgage you can choose to refinance, or renegotiate the terms of your interest rate when rates lower or your credit score improves. You can also use your home as collateral for a home equity loan. Most people will do this to make improvements to their home, thus raising the value. You can also take out a second mortgage once your first has been paid off for things like remodeling, college expenses, or whatever else you may need.
- Interest rates: There are different types of interest rates available to you, as well as different interest rate ranges. The ranges of interest rates depend on the overall economy and your own personal credit score. The types are fixed, meaning that it will stay the same over the entire course of your mortgage, or variable, which means that you may pay a smaller interest rate up front, but you will have to pay a larger amount later. This doesn’t benefit you, unless you think that your income will grow later on and you can handle the larger payment. Make sure the bank explains all of your options to you clearly, before getting stuck later on.
- Fees: The buyer and the seller can negotiate the cost of fees, but most of the time the cost will come down to the buyer. Closing costs is the money due at the signing of the contract and used for mortgage insurance, title search fees, credit checks, appraisal fees, property taxes, and homeowner’s insurance. There may also be “points” that you choose to pay which can help lower your interest. Other fees may be added depending on what the seller agrees to pay.
- Lengthy process: When we bought our house, we decided on buying it in February and we didn’t close until May. This is because there is a lot of price negotiation, inspections, appraisals, and repairs that needed to be done before the bank would approve the loan. Then we needed to make sure we had homeowners insurance, which we had to shop around for. The bank takes a very long time looking through your credit worthiness and making sure that you will be able to handle the obligation of home ownership. During this time, you are advised NOT to use any credit or open any new debts, as this will cause a negative impact to your credit score.
- Negative impact on credit score: Just like with any credit application, there will be a temporary decrease to your credit score, but with timely payments you will actually grow your credit score.
As you can see, there is a lot to know before buying a home, but this is one of those cases where the benefits do outweigh the risks, if you are already financially secure.
Also known as personal lines of credit, personal loans are amounts you can borrow from the bank with a fixed interest rate and a regular monthly payment. These can be especially useful because you can use them for whatever you like. You can use them as a debt consolidation loan, which means you use the money to pay off all of your debts and then you only have one monthly payment with a much lower interest rate (this ONLY works if you don’t run up your debt again). You can use them for emergencies, purchases, or whatever you need extra cash for. If you are new to building your credit and you don’t want a credit card, you might get a small loan that you can make payments on just to raise your credit score. Just with any of the other kinds of debt, you need to be careful not to dig a hole for yourself with a personal loan and take out more that you can afford.
- Lower interest rate than credit cards: I have seen credit card interest rates as high as 26.99%. While sometimes they offer you a 0% introductory rate, those rates soon skyrocket and are compounded daily. Personal loans, however, are a much lower interest rate, and the rate is figured into the payment ahead of time, depending on the time frame you have taken the loan out for. So, when you make those payments, they are actually paying off the debt.
- Higher borrowing limits: A credit card may offer you a $1000.00 credit limit, but you may be able to qualify for a $5000.00 personal loan.
- Building credit score: Just like with other debts, making your payments can build your credit score.
- Consolidation: You can use this money to help consolidate your other debts into a more manageable payment.
- Freedom: You can use this money for anything you like. Unlike a car loan, student loan, or home loan, you are not restricted by terms of this loan.
- Quick approval: Personal loans can often be done through a bank online and you may have your funds in 24 hours! This beats waiting around for a credit card to come in the mail!
- Low risk: Banks make sure before hand that you can afford your payments. Whereas credit cards will offer you credit and make more money off of you NOT paying, banks will not lend you what you can’t afford.
- Negative impact on credit score: Just like with ALL other debts, when you apply there will be a temporary negative impact on your credit score.
- Interest rates: Although lower than credit card, you may have to pay a higher interest rate due to a poor credit score.
- Fees: You may have to pay an application fee, late fees for late payments, and (rarely) prepayment fees, which occurs if you pay your loan off early. Most places don’t do this anymore, but make sure before you sign.
- Collateral: If you have a lower credit score, you may be asked for collateral, which is basically saying that if you don’t make your payments, they will take an asset from you. Some people will use their car, their home, etc. for collateral. Some banks will ask for cash as collateral. Again, if you have a decent credit score in the first place, this shouldn’t be a problem.
We have looked at all the basic types of debts one could have and talked about the pros and cons of all of them. As you can see, there are options for everything you may need, which is nice to have, BUT you have to be careful and make good choices. Knowing as much as possible about each type of debt will help you keep your expectations realistic. Any type of debt you incur, if you aren’t already in debt, should be something that will help you in the long run and will help boost your credit and your financial wellness. Anything that you do impulsively or if you just can’t afford it in the long run, can cause you financial hardship, stress, and lack of confidence. If you can control it, don’t let yourself get in this situation. If you are already in this situation, look for help with free credit counseling services online or through your financial institution. Click here for you FREE DEBT TRACKER to help monitor your debt.
Here are some other FREE FINANCIAL TRACKERS to print:
I hope our discussion on debts has been informative and helpful to you. Please let me know if there are any other issues you’d like me to discuss in future posts, or if you found any of this helpful. Look for Being Grown Up on Facebook, Instagram, and Pinterest and look for podcasts at Anchor.fm/kim-stamler or through your favorite podcast subscriber. Take care, friends! XOXO