The Five Pillars of Personal Finance: #5 Borrow
Personal finance has a lot of different aspects. There is so much to learn, but where do you start, and how much do you need to learn in order to handle your finances successfully? When it comes down to it, there are a handful of principles you need to know, the 5 pillars of personal finance:
Earn
Save and invest
Protect
Spend
Borrow
Today we explore the fifth pillar, borrow.
Credit required
The U.S., perhaps more than any other country, runs on credit, and that means you need a credit score. If you want to rent an apartment, qualify for certain jobs, be approved for a credit card or any type of loan, the potential lender will check your credit.
Establishing credit can be an uphill climb for those new to the U.S. financial system. That's why we created Upwardli. We help you establish a credit history and grow your credit score. There is no credit check, and you don't need a Social Security number. Join Upwardli now and start your credit journey today!
Not all debt is bad
Credit is essentially debt; you're borrowing money. And most of us will need to borrow money to buy a vehicle, a home, start a business, or pay for college. We don't have the cash to pay for those things on our own.
Credit cards are often demonized but used correctly, they can be a beneficial financial tool. The right credit card can give you perks like cash back, travel benefits, and some consumer protections.
Debt can become a problem when we use it to pay for things we can't afford.
Interest
When you borrow money via using a credit card or taking out a loan, you are charged interest. The interest rate is the cost to borrow that money. The better your credit score, the better interest rate you'll be offered.
Interest rates are an important factor in your financial life and significantly impact many other areas of your life. Even a small difference in interest rates can save you or cost you thousands of dollars over the life of a loan. Consider the example of a mortgage:
You buy a home for $100,000 with a 20% downpayment, so you borrow $80,000 with a 30-year term at:
6% interest
7% interest
The interest on the loans is:
6%: $92,670.55
7%: $111,607.12
So including the principal of $80,000, the total cost of the loan was:
6%: $172,670.55
7%: $191,607.12
Just that 1% difference in interest would save you nearly $20,000 over the life of the loan.
Strategic borrowing
The first thing to address when considering borrowing money is your credit score. You don't need to wait for the perfect score, but you do want to aim for a score of at least 760. A 760 score is generally what you need to get the best interest rates.
It's not always possible to wait, if you need to buy a vehicle, for instance. But if you can put off applying for a loan and work on your credit to reach 760, you can save thousands of dollars.
Next, as mentioned above, don't borrow money to buy things you can't afford. In the case of credit cards, that means only making charges you can pay off in full each month. A credit card is not an emergency fund, and it's not free money.
In the case of things like vehicles and a home, it means not buying a more expensive one than you can afford or need. A $20,000 car in good condition will get you from Point A to Point B in exactly the same manner as a $60,000 car.
And because housing is typically the most significant monthly expense for most people, buying "more house than you need" can result in being very cash-strapped and even foreclosure, which will wreck your credit score.
There are calculators that can help you determine how much you can afford for a vehicle or home. Consult them before you start shopping around so you know what your budget is.
Thanks to the internet, there are far more options for loans than the few banks local to you. This allows you to "window shop" for loan terms and rates to find the best deal. Most of us shop around for the best deal when making a large purchase; loans should be no different.
A solid foundation
If you want to learn more about the many aspects of personal finance, we have created dozens of helpful resources. Learning more is a good thing, but there is no need to be overwhelmed. The 5 pillars will help you build a solid financial life.