The Vault January 2011: Debt–Good, Bad, and Ugly
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All about debt
“Neither borrower nor lender be,” said Shakespeare, and it’s not bad advice. If you can afford to pay cash for something, you’ll avoid interest payments and being at the mercy of borrowers. Still, almost nobody buys a home or car with cash. And businesses borrow to expand, buy equipment, and even buy other businesses.
What is debt?
A debt is something you owe someone. If you borrow five bucks from a friend for lunch, you owe a debt of five dollars. Things get more complicated when you borrow from banks or credit card companies, because they charge you interest.
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What is interest?
Interest is a fee that is paid from a borrower to a lender. When you put your money in a savings account, the bank is borrowing it from you. They pay you interest. When someone else borrows that money, they pay interest to the bank. The amount banks pay to savers is always less than what they charge to borrowers. That’s how banks make money.
How much does it really cost?
Let’s say you borrow $5,000 to buy a used car at 6% interest, payable over 5 years. Your payment is only $95 a month—not bad. But you’ll pay $730 in interest over the life of the loan. Your car just went up by 15%! If you can afford to pay cash—or just make more than the minimum payment each month— you’ll save a bundle!
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Shop around
Different lenders charge different fees and interest rates. Nowadays, it’s pretty easy to comparison shop for credit cards and loans using sites like www.bankrate.com and www.cardratings.com. Read the fine print and make sure you know what you’re getting into. And, know that credit unions often provide better rates than commercial banks.
Pay on time—or pay big
What can happen if you you’re late with a payment or miss one altogether?
* The interest rate might go up (sometimes a lot!)
* You might have to pay penalties
* Your credit rating can take a hit
On the other hand, if you pay your credit card bill in full every month, you won’t pay interest at all!
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Buy now, pay later?
“No payments until 2015!” Furniture stores, computer stores, auto dealers—even online stores…seems like a lot of people are nice enough to delay your payments these days. But be careful—that’s a loan you’re getting, and it’s probably a high-interest loan, too. If you’re one day late with the balance, you pay all the interest that has accrued—and that can be a nasty shock.
Recap!
* Shop around for the best rates
* Don’t borrow more than you can afford to pay back
* Make payments on time, or early
* Pay cash whenever possible!
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