Interest rates are based on a percentage of the principal of a debt. You can both owe and be owed interest, depending on your scenario. Interest is a powerful force in the world of finances, and it is important that you do everything you can to stay in the good graces of this force.
If you’re like me, you’ve heard all kinds of things about interest in your life. I can remember my 4th grade teacher telling me that credit cards were the devil and that we should never open one because of interest. I also remember being told that the bank pays so much interest that it is easy to become rich. Having heard these kinds of things as a kid, I realize how broken many people’s grasp of what interest is and how it works really is. In this post, we are going to look at: What is interest? Why should I care about interest rates? Credit card interest, Interest on my student loans
Let’s start off with the basics: What is interest? – It’s the price paid to borrow money or the price owed to you for lending money. This interest will typically take the form of a percentage of the principal debt. There are two types of interest rates:
Fixed Interest Rates
A fixed interest rate is a percentage rate that will remain the same throughout the life of the debt. Fixed interest rates are favorable to many as they offer the borrower a sense of stability and predictability about their finances. It is much easier to run the numbers on a loan (say, a mortgage) and determine exactly how much will be paid in interest over the life of the loan if the interest rate remains constant over the life of the loan.
Variable Interest Rates
Variable interest rates can fluctuate from year to year. The interest rate is based on whatever benchmark your loaner uses to set your interest rate. Although these interest rates lack predictability, they offer much more potential reward than fixed interest rates. Simply put, if the interest rate falls, you save money, but if it rises, you pay more in interest.
Why you should understand interest rates
Unless you’re swimming in money, there is a pretty good chance you are going to have quite a few interactions with lenders throughout your life. From credit cards to mortgages, life is chock full of loans. And getting the best of these loans can make all the difference in whether you’re getting a good deal or if you’re getting completely ripped off.
Being able to understand a loan is a huge part of being a fully functioning adult. It’s a core part of being financially literate as well as competent.
Credit Card Interest Rates
Credit card offers come in all different shapes and sizes, but we want to focus on the interest rates.
First, let’s talk about the difference between APR and interest rates.
Understanding APR
APR (Annual Percentage Rate) is the inclusion or addition of fees and other payments to your interest rate. So, it is to inform you of the total amount you will owe on your loan.
Interest Rates
Interest rates are a percentage based solely on the principal you owe on a loan. Calculating the exact interest per month is different for different types of loans. For example: Credit card monthly interest is based on your average debt per day of the month, just as a mortgage is simply based on the debt left at the end of every month.
The danger of interest rates
So, why are people so afraid of credit cards? Because bad credit card habits can lead to terrible results. Here are a few of those bad habits:
- Paying minimums: Paying minimums is the best way to pay more for everything you buy. Why? Because paying minimums means you will wind up paying the most interest possible on every purchase without damaging your credit score, In fact, credit companies LOVE consumers who pay minimums because those are the people who make them all of their money. That’s right, if you want to pay 150%+ on everything you purchase, feel free to pay minimums. But for those of you who value your money, try to pay at least above the minimum.
- Not Paying: This seems obvious until you realize that people actually do it. Yes, some of these people get hit with terrible life circumstances at terrible times, and that is a whole other conversation. But some people think it will just never catch up with them, and these people lack an understanding of the system that they are in. They are also ignorant of the fact that they are not going to beat banks, credit unions, etc. at their own game. There are consequences to these actions. For instance, it will cause your credit score to plummet. Seriously, you will put yourself in a position where nobody will lend to you, it will be immensely difficult to pay off your debt, or you will have to file for bankruptcy. Note: Depending on your circumstances, you may struggle to even file for bankruptcy, so this is by no means a get-out-of jail-free card.
- Overspending: Credit cards are not free cash, and they are not to be treated as such. But the way some people use them, you would think they are. There is a level of responsibility and self-accountability that goes along with opening and using a credit card. If you abuse these concepts, you will overspend and therefore reap the consequences. It’s that simple.
Student Loan Interest Rates
Student Loans are a hot topic all around the world. There are millions of people who are up to their knees in student loans. So how can you avoid this nightmare situation? The key is to know exactly what you are up against. Only then will you understand how to combat it.
What Makes Student Loans so Bad?
- Cost of schooling: The simple cost of tuition and fees is a lot. “A lot” means tens of thousands of dollars, or more, over the span of your higher education. And this number explodes if you are planning on specializing in an area such as the medical field.
- Interest Rates: Yes, interest rates can become your #1 enemy when it comes to paying back student loans. Whether it’s a private or a federal loan, you are going to be paying the loan back with interest. Some of these loans have applicable “grace periods,” which can delay the payment of interest on the loan until graduation. But rest assured, after your grace period, you will be paying back those loans with interest.
How do I combat the negatives of student loans?
There are a couple of things you can do to fight student loan debt. The best option is to avoid it overall, which you can read about here. Here are the next basic steps:
- Calculate exactly how much money you will be receiving for college.
- Determine how much you will owe.
- Calculate the difference.
- Decide on either a federal or private loan.
- Look for loan options based on what you need. (Try not to overborrow)
- Compare the offers by looking at factors such as grace periods, interest rates, required credit scores, etc.
- Compare your finances to the loan criteria.
- Decide on a loan.
- Apply.
Note: Avoid applying for multiple loans that use “hard checks” on your credit. This can hurt your credit score. These inquiries will remain on your credit report for a number of years.
Conclusion: Loans are a part of life, but falling victim to poor financing doesn’t have to be. So, take the time to understand your financial scenario, what you can afford, and exactly what it is going to take to pay back these loans. Then take out only the appropriate loans.
