Using credit to purchase goods and services is commonplace in the U.S. If you take out a loan or use a credit card, there will be additional costs to borrow that money over the amount you owe. These costs are usually in the form of an interest rate that is based on your creditworthiness. In this blog, we will discuss the cost of borrowing and how to borrow better.
What Costs Come with Borrowing
Loans are a common way to pay for things when you don’t have the cash to pay upfront. In the U.S., it’s customary to borrow funds to finance a home purchase, buy a car or to pay for some other major expense. What’s key is knowing there is a cost to borrowing this money, which is usually an interest rate. If you’re taking out a loan, that cost will be added to the loan’s total amount. If you’re using a credit card, it will be part of the interest you pay each month on your account’s balance.
Auto loans, personal loans and credit cards do not typically have upfront costs but check with your lender first before you apply. There may be an application or loan origination fee to consider. Lenders will determine the interest rate based upon your credit score. The Federal Reserve sets the base interest rate used by lenders.
Prepare Your Credit Before You Borrow
Before you apply for a loan, it’s important to know where your finances stand. You can do this by checking your credit score. By law, you can receive a free credit report from each of the three major U.S. credit reporting bureaus each year at annualcreditreport.com. Here you can request your reports from Experian, Equifax and TransUnion that will show all your credit accounts, debts, any closed accounts and your credit score.
Review your credit reports to ensure they are accurate. You can dispute any discrepancies with the credit bureaus directly. Here are a few things you can do to improve your credit score over time:
- Make Payments On Time: Payment history is the most important part of a credit score because it accounts for 35% of your score. Payment history is used to determine the likelihood of someone paying back a loan in full and on time. Actions that can negatively impact your payment history are missing payments, late payments and defaulted loans.
- Reduce Credit Utilization: Credit utilization measures the percentage of the available credit in use and makes up another 30% of the credit score. Included in this are credit cards, lines of credit loans and home equity lines of credit or HELOCs. Keeping your balances below 30% can help improve your credit score. For example, if you have a credit card with a $10,000 limit, ensure your utilization or balance is $3,000 or less. Subsequently, reducing your utilization to way below 30% can increase your credit score.
- Dispute Credit Report Errors: Be sure to dispute any errors or suspicious activity in your credit report to get those items removed or notated.
- Build Credit via Secure Credit Card/Loan: If you're starting from scratch, another way to build your credit score is to open a secured credit card or a secured loan. These types of loans let you use your own funds held in a separate account as collateral. This lets you use and pay down the credit card or loan to establish a strong payment history. Keep in mind that you will still be charged interest.
Types of Loans
There are several lending options you can use to borrow better. Knowing how each works will help you decide which is best.
- Credit Card: A credit card is a revolving line of credit in which you borrow and pay back money, plus interest. It is important to note that interest rates will vary by lender and type of transaction. For example, purchase transactions usually have a lower interest rate compared to cash advances.
- Personal Loan: Personal loans are a convenient way to borrow a lump sum of money for a specific expense and pay it back in fixed, monthly amounts. Personal loan interest rates tend to be lower compared to credit cards, which makes them a good option. Also known as signature loans, they are based on the your credit with no collateral needed.
- Auto Loan: When you buy a car on credit, it has to be financed by the dealership or a credit union or bank. Before you start shopping, get pre-approved so you will know your maximum loan amount and be able to stay within your budget. Auto loans usually offer fixed rates with extended terms. Be sure to consider related expenses that come with a new car purchase, such as insurance, gas, parking and maintenance.
The key to getting the right loan is to do your research and select the loan that fits your budget. A good place to start is Travis Credit Union, where you can check for any pre-qualified offers without impacting your credit.
Consolidating Debt
Carrying debt on several credit cards and loans can make it difficult to calculate payments month-to-month. If you’re in this situation, consider consolidating your debt into a single loan with one monthly payment. With a personal loan, you can apply for a lump sum that lets you pay off all your other debts.
Another way to consolidate is with a credit card using a balance transfer promotion or offer that provides a low introductory interest rate for a period. Keep in mind there will be fees associated with balance transfers. Do your research and wait for the right credit card offer or promotion. In the meantime, Nerdwallet.com has more information and strategies for paying off your debt.
How Travis Credit Union Can Help
Travis Credit Union can help you borrow better with financial information and a variety of lending products. TCU offers credit cards and personal loans, as well as home equity lending options such as a home equity loan and HELOCs. Visit Traviscu.org to discover the right loan product for you.