Loans 101 (Loan Basics 1/3)

Summary

Lucy, an employee at Corporate Co., aspires to make significant purchases like her colleagues but is hesitant due to her lack of confidence in handling loans. The script explains the basics of loans, including principal, interest, and secured loans. It delves into interest rate calculations, the difference between interest rates and APR, and the impact of credit scores on APRs. The video also discusses loan repayment strategies, emphasizing the benefits of shorter loan terms despite higher monthly payments, and encourages viewers to learn more about credit scores in the next video.

Takeaways

• 😀 Lucy has aspirations to participate in financial activities like her colleagues but lacks confidence in handling loans.
• 🏦 Loans are a form of borrowed money where a lender provides a principal amount to a borrower, expecting repayment with interest.
• 💰 The interest on a loan is additional money paid to the lender for the use of their funds, calculated monthly based on the principal amount.
• 🔒 Secured loans have lower interest rates but come with the risk of asset seizure if the borrower fails to repay.
• 📊 Interest rates can be fixed or variable, with variable rates posing more risk due to their potential for significant change over time.
• 🔍 The Annual Percentage Rate (APR) includes both the interest rate and additional fees, making it a more comprehensive indicator of loan cost than just the interest rate alone.
• 📈 APRs are influenced by the borrower's credit score, with lower scores typically resulting in higher APRs.
• 📝 To calculate monthly loan payments, an online calculator can be used with the loan amount, interest rate, and term as inputs.
• 🗓 The term of a loan is crucial, as shorter terms generally mean higher monthly payments but lower overall interest paid.
• 💡 Opting for shorter loan terms or making extra repayments can significantly reduce the total interest paid over the life of the loan.
• 📚 The script encourages viewers to learn more about credit scores and to seek educational materials and loan recommendations from the company's website.

Q & A

What is the main concern of Lucy regarding loans?

Lucy's main concern is that she doesn't feel confident handling loans due to her lack of understanding of how they work.

What is the basic concept of a loan?

A loan is borrowed money where a lender, such as a bank, gives a borrower a fixed amount of money called the principal, which must be repaid with interest.

What is the difference between principal and interest in the context of loans?

The principal is the original amount of money borrowed, while interest is the additional money that the borrower must pay for using the lender's money.

Why might a bank seize an asset if a borrower fails to repay a secured loan?

A bank can seize the asset because it serves as collateral for the loan. If the borrower fails to repay, the bank has the right to take the asset to recover the loan amount.

How is the monthly interest on a loan calculated?

The monthly interest is calculated by dividing the annual interest rate by 12. For example, a 5% annual rate results in a 0.4% monthly interest rate.

What is a variable interest rate and why can it be risky?

A variable interest rate is one that can change over time, often dramatically. It can be risky because it introduces uncertainty in the loan repayment amount, especially for long-term loans.

What does APR stand for and why is it important when comparing loans?

APR stands for Annual Percentage Rate, which includes both the interest rate and any fees associated with the loan. It's important because it provides a more comprehensive view of the loan's cost, allowing for better comparison.

How does a credit score affect the APR of a loan?

A lower credit score typically results in a higher APR because lenders perceive higher risk in lending to borrowers with lower scores.

What is the significance of the loan term and how does it affect the monthly payment?

The loan term is the length of time over which the loan is to be repaid. A shorter term generally means higher monthly payments but can lead to lower total interest paid over the life of the loan.

Why are shorter loan terms beneficial despite higher monthly payments?

Shorter loan terms are beneficial because they come with lower interest rates and force the borrower to pay down the principal faster, resulting in less interest paid over time.

What additional resources are available for Lucy to learn more about credit scores and loans?

Lucy can watch the next video on 'Credit Scores and Reports 101' and visit the website for more educational material, a free credit score, and loan recommendations.

Outlines

00:00

💼 Understanding Loans

Lucy, an employee at Corporate Co., is inspired by her colleagues' financial activities like refinancing student loans, purchasing cars, and buying houses. However, she lacks confidence in handling loans. The first step for her is to understand the basics of loans, which involve borrowing money from lenders like banks. The principal is the amount borrowed, and in addition to repaying this, borrowers must pay interest. Interest is calculated monthly based on the annual rate, and it's crucial to understand that not all interest rates are fixed; some can change over time, posing risks. The Annual Percentage Rate (APR), which includes the interest rate and fees, is a more comprehensive measure to compare loan costs. Credit scores also affect APRs, with lower scores leading to higher rates. Lucy needs to consider the loan term, as shorter terms generally mean lower interest rates and faster principal repayment, ultimately reducing the total interest paid.

Keywords

💡Loans

Loans are financial instruments that allow individuals or businesses to borrow money from lenders, such as banks. In the video, Lucy's colleagues have used loans for various purposes, including refinancing student loans, purchasing cars, and buying houses. The concept of loans is central to the video's theme, illustrating the financial tools that can be used for significant life purchases and the importance of understanding how they work.

💡Principal

The principal is the original amount of money that is borrowed in a loan. In the script, Lucy is given an example of a $10,000 car loan, where $10,000 is the principal. The principal is a fundamental concept in loans, as it is the amount on which interest is calculated and must be repaid by the borrower.

💡Interest

Interest is the cost of borrowing money, which is charged by the lender in addition to the principal. The video explains that Lucy would have to pay interest on her loan, calculated as a percentage of the outstanding principal each month. Interest is a key component of loans, determining the total cost of the borrowed money over time.

💡Secured Loan

A secured loan is a type of loan that requires collateral, such as a car or a house, which the lender can seize if the borrower fails to repay the loan. The script mentions that many loans are secured due to their attractive interest rates and approval rates. Secured loans are significant in the video as they introduce the concept of risk associated with borrowing.

💡Annual Interest Rate

The annual interest rate is the percentage of the principal that is charged as interest over the course of a year. In the script, Lucy's car loan has a 5% annual interest rate, which is then divided by 12 to determine the monthly interest rate. This concept is essential in understanding how much Lucy will pay in interest each month and over the life of the loan.

💡Variable Interest Rate

A variable interest rate is an interest rate that can change over time, often linked to market conditions or a benchmark rate. The video warns that variable rates can be risky, especially for long-term loans, because they can change dramatically. This concept is important as it introduces the element of uncertainty in loan repayments.

💡APR (Annual Percentage Rate)

APR is the annual cost of borrowing, expressed as a percentage of the principal, and includes both the interest rate and any fees associated with the loan. The script emphasizes that Lucy should compare loans using APR rather than just the interest rate, as APR provides a more comprehensive view of the loan's cost. APR is a crucial concept for understanding the true cost of borrowing.

💡Credit Score

A credit score is a numerical representation of an individual's creditworthiness, which affects the interest rates and terms offered on loans. The video mentions that APRs are highly dependent on one's credit score, with lower scores resulting in higher APRs. The concept of credit scores is related to the video's theme by highlighting the importance of credit health in accessing favorable loan terms.

💡Loan Payment

A loan payment is the amount of money paid by the borrower to the lender each month, which includes both principal and interest. The script explains that Lucy's total loan payment is calculated by combining the principal repayment and the interest. Understanding loan payments is vital for budgeting and managing personal finances.

💡Loan Term

The loan term refers to the length of time over which the loan is to be repaid. The video script discusses how the term affects the monthly loan payment, with shorter terms resulting in higher monthly payments but lower total interest paid over the life of the loan. The loan term is a key factor in the video's message about the benefits of shorter loan durations.

💡Extra-Debt Repayments

Extra-debt repayments are additional payments made by the borrower beyond the regular monthly payments, aimed at reducing the principal faster and saving on interest. The video script repeats the importance of making extra repayments or choosing a shorter loan term to reduce the total interest paid. This concept is related to the video's theme by emphasizing strategies for managing and reducing loan costs.

Highlights

Lucy has been working at Corporate Co. for three years and observed her colleagues taking out loans for various purposes.

Lucy aspires to take out loans like her colleagues but lacks confidence in handling them.

Understanding how loans work is the first step for Lucy to gain confidence.

Loans are borrowed money where lenders provide a fixed amount called principal.

Borrowers must pay back the principal along with interest for using the lender's money.

Secured loans have lower interest rates but the lender can seize the asset if repayment fails.

Interest is calculated monthly based on the outstanding principal and the interest rate.

Variable interest rates can change over time, adding risk to long-term loans.

APR includes the interest rate and fees, and is a better indicator of loan cost than just the interest rate.

APRs are influenced by credit scores, with lower scores resulting in higher APRs.

Lucy can calculate her total loan payment using an online calculator with the borrowed amount, interest rate, and loan term.

The loan term is critical when choosing a loan, with shorter terms generally having higher monthly payments.

Shorter loan terms can be beneficial due to lower interest rates and faster principal repayment.

Paying off the loan faster, either through extra payments or a shorter term, results in less interest paid over time.

The video series will cover credit scores in the next installment.

The website offers educational material, free credit scores, and loan recommendations.

Transcripts

Meet Lucy.

Lucy has been working at Corporate Co. for the past three years.

Since her very first day on the job, Lucy has seen her colleagues refinance students

loans (Zoe), purchase cars (Joan), and even buy houses (Emily).

Lucy wants to be like them, there’s just one problem: all these activities require

loans, and Lucy just doesn’t feel confident handling them.

What should she to do?

Well, her first step is simple: understand how loans work.

On their most basic level, loans are simply borrowed money.

Lenders, such as banks, can give borrowers, such as Lucy, a fixed amount of money called

principal, like $10,000 to buy a car.

However, the bank isn’t giving Lucy this money for free.

In addition to paying back her principal, they’ll require Lucy to pay a certain amount

of money each month, called interest, just for using their money.

In addition, if her loan is secured, as many are due to their more attractive interest

and approval rates, the bank can seize actually the asset, in this case her car, if she fails

to repay.

So how is this interest calculated exactly?

Let’s explain through an example.

Let’s say Lucy’s $10,000 car loan comes with a 5% annual interest rate.

Divide that 5% by 12 months, and you get roughly 0.4%, the monthly interest rate.

That’s means Lucy owes the bank 0.4% of her outstanding principal each month in interest.

While this seems reasonable enough, interest rates come with three more complications:

One: Not all interest rates are fixed.

Some, called variable interest rates, can change over time, often quite dramatically.

Because of this, they can be quite risky, especially on long-term loans.

Two: the interest rate of a loan is not the same thing as its APR.

APR includes both the interest rate, either fixed or variable, and the fees.

Thus, when comparing loans to see which is cheaper, Lucy should always use APR, not the

interest rate.

Three: APRs are also highly dependent on your credit score, as the lower your score, the

higher your APR.

For more details on this, be sure check out our next video “Credit Scores and Reports

101”.

So that’s interest rates.

But unfortunately, they aren't Lucy’s only concern.

She also must pay back a certain amount of her principal each month.

This payment, combined with interest, makes up Lucy’s total loan payment, which is the

money you pay the bank each month.

Should Lucy want to calculate this number herself, all she’ll need is an online calculator,

like ours, and three numbers: the amount of money borrowed, the interest rate, and the

length of the loan, also known as its term.

This term is a critical number, especially when choosing a loan.

That’s because, in general, the shorter the term of the loan, the greater your monthly

loan payment.

This should make sense.

After all, the less time you give yourself to repay the loan, the more you'll have to

pay each month to compensate.

And while this may seem bad, shorter term loans can actually be great, for two reasons.

One: They come with inherently lower interest rates.

And two: Because their monthly payments are much larger, the borrower is forced to pay

down the principal much faster, which ultimately means less interest charged over the life

of the loan.

This fact is so important that we’ll repeat it.

The shorter you can make your loan, either through extra-debt repayments or a shorter

term, the less interest you’ll pay in the long-run.

Hopefully you and Lucy now better understand how loans work.

Be sure to watch our next video, which covers everything you need to know about credit scores,

and be sure to check out our website, where you can find more educational material, your

free credit score, and great loan recommendations.