September 19, 2009
Loans: A Good Thing When You Need Them
We borrow money for many reasons: to buy a car or a house; to remodel a home; to pay for college expenses; to open a business; and, in some cases, to pay our bills. Borrowing money allows us to get what we want today or to pay for things when we do not have enough cash. While that sounds ideal, we must remember that borrowed money must be paid back. Making poor decisions about loans can affect our long-term financial future.
As of August 2009 consumers in the United States have $950 billion in credit card debt and $1.6 trillion in auto loans and other non-revolving debt. That’s a lot of money that’s owed.
Borrowing money does not mean that we have more money. In fact, it is the opposite. Borrowing money means we are using tomorrow’s income to buy things today. If we are not careful, we will borrow too much — leaving us with a big stack of bills and no money to pay them. So when taking out a loan be sure you truly need it and that the money is not going towards items that are not essential. Remember, if you don’t pay back your loans it will hurt your credit score and it will be harder and more expensive to get loans in the future.
What it Takes To Get a Loan?
Established and satisfactory credit is the first thing you must have. For more information on credit see our article Credit. It’s your History In The Making. Steady income is the other factor lenders like to see as they want to make sure you have the means to pay the loan back.
Types of Loans
Mortgage Loans: Mortgages are loans used to buy houses and property. The lender uses the property as collateral. This means if you don’t pay back the loan the lender will take the property. The great thing about mortgage loans is that the interest you pay on a mortgage is tax deductible.
Home Equity Loans or Lines of Credit: If you have more value in your property than you owe oftentimes you can get a home equity loan or line of credit. These loans are generally used for large home improvements, education or other large purchases. In this case your property is collateral as well. If you don’t pay back the loan the lender can seize the property. With home equity loans the interest you pay is also tax deductible.
Auto Loans: These can be used to buy both new and used vehicles. The average length of loan is 48-60 months. Here again the vehicle acts as collateral and if you don’t make regular payments on the loan the car can be repossessed.
Personal Loans: You must have very good credit to get a personal loan as there is no collateral. The lender in this case is banking on the fact that you have paid back other obligations so you’ll be likely to pay a personal loan as well. You can use a personal loan for any thing you see fit. But be very careful these loans come with higher interest rates and have generally short repayment terms.
Private or Alternative Student Loans: These are like a personal loan but a bit easier to get. These are credit based loans for the sole purpose of education related costs. You must have pretty good credit for these loans as there is no collateral. Lenders can’t take your education back after all. You may also get a tax deduction for the interest you pay on a private student loan, but talk with your tax advisor to be sure.
Federal Student Loans: These are interesting. You don’t need good credit or any credit for these loans. The loan is guaranteed by the federal government and with a subsidized federal student loan the government even pays the interest while you are in school. Here’s the catch, if you don’t pay these loans back the federal government will have a claim against you and your credit history will be destroyed for a very long time.
Federal Loan Forgiveness and Student Loan Tax Credits
As stated above, federal student loans are very strange animals. Remember how we have stated over and over again that loans always need to be repaid with no exception. Well with Federal student loans there are certain circumstances where the federal government will forgive all or part of your student loans. Here are some examples of when the federal government will forgive loans:
If you serve in:
- The Peace Corps
- Volunteers in Service To America (VISTA)
- Ameri Corps
- The Army National Guard
- Become an elementary school teacher
- Become a nurse
- Work as a lawyer in many non-profit public service positions
- Work in health professions that serve public interests
To learn more about federal loan forgiveness programs visit the department of education at ed.gov.
Tax credits are also readily available for federal student loans. Check with your tax advisor about your specific situation.
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