How to use loans wisely

A loan is a form of credit that allows you to purchase something without paying upfront, such as a car, a house, or a trip. You receive a sum of money from a lender, which is typically a bank, a financial institution, or an individual, and commit to repaying it with interest within a specified period.

Interest is the amount the lender charges for the loan, usually a percentage of the borrowed amount.

This service can be used to fulfill dreams, invest in projects, or address financial emergencies. However, if not used intelligently and responsibly, it can become a trap.

Therefore, before taking out a loan, it's essential to evaluate if it's truly necessary, if you're capable of repaying it, and if it offers the best rates and terms in the market.

The first step is to understand the key elements of a loan: the principal amount, the interest rate, and the term.

Explaining this is writer and financial consultant Justin Pritchard, author of the article "Learn How Loans Work Before You Borrow" on the NerdWallet website.

"The principal amount is how much you're borrowing from the lender. The interest rate is how much the lender charges for the loan. The term is how long you have to repay," he said.

According to Pritchard, the higher the loan amount, the larger the installment. The higher the interest rate, the greater the loan cost. If the term is long, you'll have more time to repay the loan, but you'll also pay more interest.

Therefore, it's important to compare interest rates from different lenders before choosing the best one for you. One way to do this is through online pre-qualification, which doesn't affect your credit score.

Annie Millerbernd, a reporter specializing in personal loans at NerdWallet, stated that "an online pre-qualification to see the rates each lender offers doesn't affect your credit score because lenders only make a soft inquiry into your credit history. Once you've chosen the best lender for you, they'll perform an extensive inquiry into your credit history, which may slightly lower your score," she explained.


"The interest rates on personal loans, which are those that don't require collateral, depend on your repayment ability and your credit score. In other words, the higher the score, the lower the offered interest rate," she affirmed.

In addition to personal loans, other types are available in the market, catering to different needs and borrower profiles.

"There are basically two main types of loans: secured and unsecured. Secured loans require some form of collateral, such as property or a vehicle, to ensure loan repayment. If you fail to make payments, the lender can seize your asset. Consequently, secured loans typically have lower interest rates than unsecured loans," explained Julia Kagan, senior editor at Investopedia.

"Conversely, unsecured loans tend to have higher interest rates than secured loans," she elaborated.

There are also business loans designed to finance business activities, such as working capital or expansion, and student loans aimed at financing higher education.

In addition to loan types and interest rates, it's important to be aware of additional costs charged by lenders, such as opening, maintenance, or contract cancellation fees. These costs vary depending on the financial institution and the chosen loan type.

Carefully read the contract terms before signing and check for any abusive or illegal clauses.

Another crucial aspect of loans is the risk of default, which occurs when the borrower fails to make loan payments within the established timeframe.

To avoid this scenario, it's crucial to plan your budget carefully and not commit more than 30% of your income to loan payments, as loans can become a trap if not used wisely and responsibly.

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