The world of debt has rules, players and strategies. One of the best things you can do for yourself is to learn how to use debt well. When you borrow money from another person or institution (such as a bank or credit union), the lender expects to be repaid, & usually charges a fee for the use of that money.
Debt is what you owe when you borrow something—cash or tangible goods from someone else, or when you purchase on credit.
Loan refers to a sum of money that a lender gives to a borrower for a certain period of time. The borrower makes a commitment to repay the money with interest.
Credit is the ability to borrow, or the sum available for borrowing. Banks and other financial institutions will approve credit to customers who have a good record of repaying their loans on time.
Default is failure to pay back a loan.
If you borrow money from a bank or other formal lender, you will hear the following terms associated with your loan:
Loan size: The amount you borrow.
Loan term: Period of time you have to use the loan money and repay it.
Interest rate: Percentage of the total loan amount charged to the borrower for the use of money borrowed. Interest is usually charged on a monthly basis.
Fees:Administrative charges in addition to interest which are usually paid once, at the time the borrower takes the loan.
Grace period: Period after receiving a loan and before the first payment is due.
Repayment schedule: The frequency of loan payments (e.g., weekly, biweekly, monthly).
|Use of Debt||Good Debt||Bad Debt|
|Purchasing an Asset or Consumer Durable||The asset or goods purchased outlast the time it takes to pay off the lender.The income earned from the asset exceeds cost of the loan||Debt is still owed after the item is consumed or the income earned from the asset is less than the cost of the loan.|
|Working Capital||The loan makes it possible to pursue a business opportunity that is profitable enough to repay the loan and have something left.
The loan helps you save money on inputs or inventory and thus increase your earnings from the final product.
|You cannot earn enough to repay the loan.
You have other less-costly sources of financing.
You cannot get the loan in time to take full advantage of a specific opportunity.
|Emergency Loan||The loan helps you solve an immediate problem without undue hardship.||The loan terms are too costly, or cannot be adjusted to your ability to repay.|
The main cost associated with a loan is the interest charged for the use of the money. This is usually calculated as a percentage of the total loan amount and you typically pay it in monthly instalments as part of your loan payment. In addition, many lenders also charge administrative fees which you usually pay once, when you take the loan. Interest and fees are charges that you pay directly to the lender. These ―direct costs are usually cash payments.
Two simple rules will help you control your debt: