2. Compare the Sources of Consumer Credit
b. Compare Annual Percentage Rates (APR) and Total Credit Costs for a Given Loan Amount and Time Frame from Three Different Lenders.
We cautioned you earlier that using a credit card
for cash advances results in very high costs. Let’s look at three different types of loan examples.
– When you use a credit card
, the credit card
company is loaning you money without any collateral
. You remember that this is called an unsecured loan. Because your loan is unsecured, it’s a riskier loan for lenders, so they charge you a higher rate, often at 18 to 22 percent or even higher. With secured loans
, it’s a different story—a story of lower rates.
– A bank
or credit union
you money for such items as cars, recreational vehicles, and homes. These loans
are secured by the value of the item being purchased. With less risk, they can loan you money at lower rates. Historically, there is always a difference between rates for different types of products, based on their value as collateral
. For example, while a local credit union
is offering new auto loans
for 36 months at 6 percent and for 48 months at 6.46 percent, they would typically charge 7.21 percent for used cars because they have less value.
– Once you have a home loan (mortgage
) that is secured (backed by the house), you become eligible for a usually low-interest, short-term loan called a Home Equity
Line of Credit loan or a HELOC. HELOC loans
are available from banks , credit unions , and mortgage
companies. They can be taken out as a lump sum or as a line-of-credit that allows you to charge in any increments up to the maximum amount of your HELOC at any given time. In our example below, a HELOC loan for $30,000 was available for 5.21 percent as a line-of-credit and for 7.31 percent as a lump sum. The table below illustrates the advantages of using a low-interest loan.
|Source of Loan
||Type of Loan
||Annual Cost for $30,000 Loan
||When Interest Begins to Accumulate
||20 to 25 days
||Only when used
With a line-of-credit loan, the lending agency has preapproved you for a given amount of money. You can draw upon this money as needed without paying any interest until you actually use it and, then you only pay interest on the amount you actually use—not the total amount available. Since the loan is secured by your house, the rate is low. Institutions believe that lending you money on a house is a better risk for them because, if you default
, they would take over an asset
that has often gained in value, which is quite the opposite of a car loan.
Another advantage of a HELOC is that it is available for flexible uses. Once the amount (say $30,000) is approved for your use, you can use it for a car, for education, for whatever you believe is worth paying interest to purchase. And, in contrast to a credit card
loan, it could save you more than $5,000 per year in interest--$1,563 rather than $6,600. Finally, another advantage of any type of home loan is that a portion of the interest can be reported as a deduction when filing taxes.