Having and using credit is convenient but it usually costs something and it needs to be paid back. It is important to understand the costs of different forms of credit. Some forms of credit may be easier to obtain than others, but they often come with a high cost.
If you are thinking about borrowing money or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it. Then you should shop for the best terms. When applying for credit, there are three main terms you need to be familiar with:
- Principal –The amount of money you are borrowing.
- Interest Rate – What the lender charges you to allow you to use their money. It is a percentage of the principal (charged per year, month, or week.)
- Fees– Cover the lender’s costs to review your credit application or to service your account (These can be maintenance fees, service charges, late fees.)
Because it costs money to use credit, in general, credit should be used for things that have a useful life beyond when you finish paying your debt, like a home purchase.
Ana and Tom Velasquez recently got their credit fixed and bought their first house from Rapid Home Solutions! They are throwing a huge house-warming party and watching the biggest boxing match in years.
Tom really wants to buy new flat screen TV to watch the fight on. But, it will cost him a good $500. After talking about it, Tom promises Ana that he would do some digging and find the best possible deal for them. He researched the following four options.
Tom and Ana decide to borrow a TV from Tom’s brother for the night of the party and to save money each month so they can pay cash for a new, much bigger TV in a few months… and have extra money left over for a surround sound speaker system too, all while remaining debt-free!
Now, Tom was thinking smart here. He made a responsible decision – saving money while keeping himself and his family out of unnecessary debt.
Cost of New TV: $500.00
$ 4,425Total Owed by Tom
- If Tom gets a $500 loan at a payday lender with a biweekly interest rate of 20%, he would pay $100.07 every two weeks for 21 months for a total cost of $4,425.01.
Addition cost for Tom is: $3,925.01
$ 1,109Total Owed by Tom
- Tom would pay $13.99 per week for 18 months for a stereo from a Rent-to-Own store, costing a total of $1,109.22.
Addition cost for Tom is: $609.22
$ 812Total Owed by Tom
- Tom could use a credit card to purchase the stereo. If the card interest rate was 24% and he only paid the minimum payments, the TV, plus interest would cost $812.71.
Addition cost for Tom is: $312.71
CashBEST OPTION FOR TOM
$ 500Total Owed by Tom
- If Tom waits to buy the TV until he is able to save money to pay cash, it will only cost him $500.
Addition cost for Tom is: $0