Borrowing cash can be good when used wisely. It can improve a family’s level of living. For example, most people use credit to buy their homes. The main reason most people use credit is that they do not have the cash to pay the total cost of an item or service at one time.
By: Hitesh Khan/
Another reason for borrowing cash is that it may be easier to pay for an item through regular installment payments.
Having the ability to borrow money when you need it gives you flexibility. But borrowing too much money and being unable to pay it back is a serious problem in our country. In fact, the fastest growing group declaring bankruptcy is age twenty-one to twenty-eight. It’s important to use credit responsibly and avoid having too much debt. If you understand how credit works and use it wisely, it can help you to reach your goals.
When Borrowing cash remember the Credit benefit zone
The benefits of having credit are:
- The option of buying something today and paying the money back over time, rather than having to wait
- The flexibility to act on major purchases and life opportunities that may require more money than you have on hand right now, like buying a computer, or borrowing for college
- Easier to rent an apartment and to get service from local utility companies
- Easier to buy what you want, when you want it
Credit risk zone
The risks of having credit are:
- Overdoing it; borrowing more than you can afford to repay
- If you don’t make your payments on time, you’ll damage your credit record
- Losing money on late fees
- Having to pay additional interest
- Difficulty getting loans or credit in the future
How much debt can you repay?
General guideline #1:
Never borrow more than 20% of your yearly net income.
General guideline #2:
Keep your credit card debt low enough so that your required payments are no more than 10% of your monthly income.
Good credit vs. bad credit
|Good credit||Bad credit|
|Good credit signs:
Paying at least the minimum required payment
Paying on time
Never missing a payment
Staying within your credit limit
|Bad credit signs:
Paying too little
Paying too late
Going over your credit limit
Easier to borrow money
No additional penalty fees
Difficult to borrow money
You lose money on late fees
How do lenders decide whether or not to loan you money? Many look at five factors.
When lenders evaluate character, they look at stability — for example, how long you’ve lived at your current address, how long you’ve been in your current job, and whether you have a good record of paying your bills on time and in full. If you want a loan for your business, the lender may consider your experience and track record in your business and industry to evaluate how trustworthy you are to repay.
Capacity refers to considering your other debts and expenses when determining your ability to repay the loan. Creditors evaluate your debt-to-income ratio, that is, how much you owe compared to how much you earn. The lower your ratio, the more confident creditors will be in your capacity to repay the money you borrow
Capital refers to your net worth — the value of your assets minus your liabilities. In simple terms, how much you own (for example, real estate, cash, and investments) minus how much you owe.
Collateral refers to any asset of a borrower (for example, a home) that a lender has a right to take ownership of and use to pay the debt if the borrower is unable to make the loan payments as agreed.
Some lenders may require a guarantee in addition to collateral. A guarantee means that another person signs a document promising to repay the loan if you can’t.
Lenders consider a number of outside circumstances that may affect the borrower’s financial situation and ability to repay, for example what’s happening in the local economy. If the borrower is a business, the lender may evaluate the financial health of the borrower’s industry, their local market, and competition.
Some lenders develop their own loan decision “scorecards” using aspects of the 5 C’s and other factors. Example: borrower’s credit used vs. credit available.
When borrowing cash, remember that the money you borrow is yours to spend, but you’re taking on a real responsibility to pay the money back! You need to make monthly loan payments and usually have other costs called interest and fees.
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