April is Financial Literacy Month. In no area of people’s financial lives is financial literacy more important than when borrowing money, which nearly everyone needs to do at some point to pay for major expenses. Understanding lending and credit can help you to navigate the financial system smoothly.
Borrowing to buy a house, get a student loan or start a business can be a sensible investment.
Unless you are able to live rent-free by moving back in with your parents after you graduate, you will be paying for housing, either through rent or through mortgage payments. Buying a home has several advantages over paying rent from an investment standpoint: It allows you to build equity or value and it protects your savings from inflation.
Student loans have the potential to pay for themselves many times over, despite their high cost. Student loans routinely amount to many thousands of dollars just for undergraduate school. Professionals in the legal and medical fields require additional education that will cost tens of thousands more dollars. All of these costs may make student loans a necessity. Assuming you graduate from a good school with a degree that is in demand, you have a high probability of obtaining a job that will allow you to repay your student loan within a relatively short period of time.
Starting a business
Many startup companies avail themselves of business loans for working capital until they are able to become self-sustaining. Small-business entrepreneurs may even use loan proceeds to pay for living expenses while the business is getting off the ground. Through loan refinancing, it’s often possible to build a business while still paying off a student loan. Companies like Figure stand ready to help you accomplish these twin aims.
Using credit responsibly
Credit cards are powerful financial tools for borrowing that can provide valuable benefits. However, you need to use them responsibly to fully realize those benefits. Important tips for using credit cards include making payments on time, avoiding excessive debt and tracking your charges.
Make payments on time
Paying your bill on time is the single most important thing you need to do when you have a credit card. It’s the biggest factor in your credit score and, therefore, the key to building a healthy credit record. Paying on time means that your credit company receives the payment by the due date and that the payment is at least equal to the minimum amount due. Late payments result in penalties such as late fees and higher interest rates, which your credit card company can report to consumer credit bureaus. Assuming you have the money, the easiest way to make your payments on time is to set up an automatic payment plan through your bank or credit union.
Avoid excessive debt
Total debt is the next-largest factor after payment history in determining your credit rating. It's always better to have less debt than more. Most credit experts agree that you shouldn't use more than 30% of your available credit. It's particularly important to avoid carrying a balance on credit cards due to their high interest rates. If you know when you apply for a card that you’re likely to carry a balance, you should choose a non-rewards credit card since they typically charge lower interest rates than rewards cards.
Monitor your charges
Review your credit card statement each month for errors, especially overcharges and unexpected charges. While these errors often are innocent mistakes, they also can indicate fraudulent charges. U.S. laws provide consumers with a number of protections against credit card fraud, but it's still up to you to identify these charges and report them to your card issuer.
No matter how carefully you plan to avoid debt, you may still find yourself needing to borrow money at some point in your life. Events such as a job loss or unexpected expense can place you in the position of needing a loan just to survive. However, it’s possible for a loan to actually improve your credit if you borrow responsibly.
Borrow what you need
Lenders will often want you to borrow the maximum amount they’ve approved you for, even when you don’t need that much. They know that you’re likely to spend it, resulting in your paying them more in interest. While it’s sensible to borrow slightly more than your immediate needs to cover future unexpected expenses, you should resist the temptation to borrow as much as the lender will let you have. To reduce your chances of spending any leftover money from the loan, you should put it in an account that you can’t easily access.
Long-term vs. short-term
Short-term loans generally have higher interest rates, because the lender has less time to earn a return on the loan. However, by taking advantage of introductory offers, you may be able to avoid the higher costs associated with short-term loans. Many credit cards have an introductory rate of zero percent. This means the credit issuer won’t charge you any interest at all for a certain period, typically the first year. While the interest rate after that point is often very high, that won’t matter if you pay off your entire balance before the introductory period expires.
Consult with an expert
Always consult with someone before you borrow money. It needn’t be a professional financial adviser, so long as it’s someone you trust who knows more about money than you do. It’s also important to obtain offers from more than one lender and to go beyond simply comparing their interest rates. Compare all of their loan terms.
Figure will be educating readers on additional topics during Financial Literacy Month, so watch for them. These articles target primarily young adults who are learning how to manage their finances. Figure also provides financial tools and solutions for borrowers, especially for homeowners.