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The Realities of Loan Finance

The Realities of Loan Finance

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Most people will need to borrow money at some point in their lives. Whether it’s for a car or for the purchase of a new house, there are times when debt is a near necessity and a great convenience. Working with lenders might seem like a daunting task, but it’s important to realize that they can provide a beneficial service if you’re looking to achieve certain goals like getting an education or owning a home.

The Realities of Borrowing Money

Lending money is a business. Whether it’s business loans via the bank downtown or fast cash personal loans online, the lending party expects to generate revenue through the arrangement thanks to interest. Borrowers have to be aware of this fact before they decide to go through with a loan application. It’s not the job of the lender to check your knowledge about the process, this responsibility lies squarely on your shoulders. Carefully read over the terms and conditions of your loan contract prior to signing. Simply put, have an understanding of what you’re getting yourself into. If you’re aware of the fact this is a business transaction and not some sort of magic way to get money, you’ll fare far better in managing the repayment process.

How Compound Interest Works

When some people think of interest payments, they have an erroneous assumption. For example, they’ll think that a mortgage payment of $1,000 at an interest rate of 4 percent will see a reduction in the principal amount of $960 in the first month. This is why understanding compound interest is very important. The equation for figuring interest is as follows: Interest = Principal x Rate x Time. This means that an individual with an interest rate of 4 percent on a 30-year, $100,000 loan will pay about $4,000 in interest in the first year. For a 6-percent rate on a similar loan, the borrower would pay $6,000 in interest. The amortization of the loan means that very little of the payment will go toward the loan in the early years of repayment. When the 4-percent loan gets down to $10,000 owed, the borrower would only pay about $400 in interest during the year.

Avoiding Interest

The best way to avoid interest payments is to pay in cash for everything. This is not feasible for many people, however. Many, if not most, locales in the US have home prices that are well into the six figures. Some will have average prices that are $500,000, $1 million, or more. It can be quite difficult to pay cash for these houses, but this does not mean that you cannot cut down on your interest payments.

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Here are a couple of important strategies to avoid interest. First, make sure that you keep up a strong payment history so that you can have a good credit score. A better credit score will usually come with a lower interest rate when you decide to borrow. Secondly, prepaying some of the loan will cut down on the amount of the interest payment that’s owed in the future. This can make sense in some situations, especially when the interest rate is higher than the return that an investor could expect to get from investing. Some loans have a prepayment penalty, so it’s a good idea to check before making additional payments. You’re not a helpless victim in the process, so you could always decide to refinance if this is the case.

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