Borrowing Wisely

Borrow Only What You Need

It’s tempting to borrow extra money, just in case. But keep in mind that loans are not free. You’ll need to pay back everything you borrow, plus interest. When you’re determining how much money you want to borrow, plan to have it pay only educational expenses – not entertainment and lifestyle choices. Your loan agreement will likely require you to do this, too.

Before you borrow money, consider your anticipated income and living expenses after graduation, so you can predict what you’ll be able to afford in monthly loan payments.

Understand the Basics

There’s more to borrowing money than just signing on the dotted line. The extent to which you understand the cost and subtle intricacies of borrowing will affect your ability to effectively manage your debt.

One thing that’s helpful is to be familiar with common terms associated with borrowing:

  • Principal – amount of money the lender loans to you
  • Interest – additional amount that you pay to the lender for the privilege of using the money they are lending you
  • Capitalization – process of adding accrued interest to the principal amount owed
  • Accrue – accumulation of interest

Remember, the total amount you owe on your loan is much higher than the amount you receive because of the interest. For example, if you borrow $10,000 at an interest rate of 8.25%, your payments may look something like this:

Loan amount: $10,000
Interest rate: 8.25%
Repayment period: 10 years
Number of payments: 120
Each payment: $122.65
Total amount repaid: $14,718

Making Payments

Note: This section does not apply to Stafford Loans

Another important point to remember about borrowing is that loans are structured to put most of your initial payments toward the interest you owe, rather than toward repaying the principal.

For example, suppose you decide to pay off a loan after you’ve been making payments for three years. You may be surprised to find out that your principal has not been reduced as much as you thought because the majority of your payments over those first three years went to pay off the interest portion of the loan, not the principal.

With revolving credit such as a credit card, the picture can be even more dramatic. If you have a high enough balance and make low enough payments, you may not be repaying the principal at all. In that case, your debt will just continue to increase.

Let’s say that you have a $5,000 balance at a 17% interest rate. If you paid $100 a month for 36 months, your new balance should be approximately $1,400. Instead, due to the structure of most credit-based loans, your monthly payment is applied toward the interest first. That means out of the $3,600 you paid, only $1,346 went toward the principal. In reality, you still owe $3,654. And if you continue paying $100 each month, it would take seven-and-a-half years to pay off the $5,000, and with interest you’d have paid a total of $8,819.

TIP: Be sure to make loan payments as scheduled or you may be charged late fees and collection costs

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