Line of Credit

Line of Credit
A line of credit is a flexible loan that grants a borrower access to money (up to a specified maximum amount determined by the bank or lender). Interest is only charged on the money that the borrower chooses to use.

What is a Line of Credit?

A line of credit is a type of loan that provides a borrower access to a certain amount of money. As long as they do not exceed that maximum amount, the borrower can withdraw funds as they see fit. That maximum amount that a borrower can withdraw is called the “credit limit.” Interest is only charged on funds that the borrower withdraws.

With a typical bank loan, a borrower receives their funds in a single lump sum then pays off the principal and interest for that entire amount. But with a line of credit, the borrower is able to withdraw any amount of money up to their credit limit and will only have to repay what they actually borrowed. Additionally, interest will only accrue on funds that have been withdrawn.[1]

How does a Line of Credit work?

A line of credit (LOC) is what’s referred to as a “revolving account.” This means that you can withdraw funds within your limit, pay them off, and then withdraw them again if needed. Borrowers have the choice to pay off their balance in full or make minimum payments and maintain a balance on the line of credit.  There are some lines of credit where the available funds do not replenish as the line is paid off. These are referred to as “non-revolving accounts.”

When you get an LOC you’ll have a “draw period” and a “repayment period.” The draw period is the time during which you’re using the account and withdrawing funds as needed. This can last for up to 10 years depending on the terms set by the lender. When the draw period ends, the LOC goes into its repayment period: the time during which the total balance and interest are repaid. Additional funds cannot be accessed during repayment unless the line is renewed.[2]

What are the different types of Lines of Credit?

A majority of credit lines are unsecured loans that come in two different forms: personal or business. This means that many lines of credit won’t require you to offer up any collateral. However, there are secured lines of credit as well, like a Home Equity Line of Credit (HELOC). To get a HELOC, you’ll contact a mortgage lender or financial institution and offer up your home as collateral in order to secure the funds. In cases where the borrower still owes money on their first mortgage, the HELOC is secured by the value of your home above and beyond what is still owed on that mortgage. If you fail to make your payments on a HELOC, the lender can then seize your property to make up for their losses. A HELOC would be considered a personal line of credit.[3]

Personal lines of credit can be difficult to obtain if they’re unsecured. They’re generally only offered to those with high credit scores. The credit limit for these products is typically much higher than a normal credit card limit, and all the bank has to secure the loan is your word. A business line of credit works just like a personal LOC; the difference is that you can only use those funds for business purposes.

What are the Pros and Cons of Lines of Credit?

The appeal of a line of credit over a credit card or personal installment loan is cost: the Annual Percentage Rate (APR) for an LOC is usually much lower. They also come with higher limits, which makes the purchase of big-ticket items possible. The flexibility of an LOC is another reason people opt for these over traditional loans. Using an LOC gives you the power to choose how much money you withdraw, how often, and for what purpose.

There are many advantages to using a line of credit, but there are also disadvantages. If you choose a HELOC, you run the risk of having your home seized if you don’t make your payments. And you may not even be able to get an unsecured line of credit unless your credit score is very good. Most LOC’s come with adjustable interest rates, which means the lender can increase your interest rate and monthly payments. Make sure you know the terms of the LOC before agreeing to one.[4]

References:

  1. Fay, Bill. “Line of Credit” Debt.org. Investopedia. Accessed August 3, 2016. https://www.investopedia.com/terms/l/lineofcredit.asp

  2. “How a Line of Credit Works” Banking.com. Accessed August 3, 2016. https://banking.about.com/od/loans/p/lineofcredit.htm

  3. Barrymore, John “How Lines of Credit Work” HowStuffWorks Money. Accessed August 3, 2016. https://money.howstuffworks.com/personal-finance/banking/lines-of-credit.htm

  4. Warden, Peter “Pros and Cons of a Personal Line of Credit” LendingTree. August 11, 2015. https://www.lendingtree.com/personal-loan/pros-and-cons-of-a-personal-line-of-credit-article

Give Me Some Credit: Line of Credit VS Credit Card (3 of 3)

CC3 (12)

By this point you’re probably familiar with what a credit card is and how to use it. What you may not be as familiar with are other credit-based products, how to get them, and how they work. One of these products is referred to as a “line of credit”, and while it does have many similarities to a normal credit card account, there are also some big differences.

What is a line of credit?

A line of credit is a flexible loan that you can find through a bank or other financial institution. With a regular loan, you’re issued a certain amount of money, and charged interest on that amount until you repay the loan in full. A line of credit however, provides you with a credit limit (similar to a credit card) that you can borrow from, while only paying interest on the amount you use. Just like credit cards, lines of credit will maintain a revolving balance if not paid in full after each purchase.[1]

The similarities

Credit cards and lines of credit have many things in common. As mentioned above, both options allow you to make minimum payments and maintain a revolving balance, or pay off the entire balance at the end of each month. Regardless of which one you choose to get, it’s always a good idea to pay the balance in full and avoid high amounts of interest.

Another similarity is that both of these options have a preset limit. This means you can only spend up to a certain amount. In addition, your payments and activity will be reported to the credit bureaus whether you’re using a credit card or line of credit. This is why it’s important to always make timely payments no matter which one you’re using.[2]

The differences

While a line of credit and a credit card may seem like the same thing, there are many key differences that separate them. First, people choose to use them for very different reasons. A credit card is generally used for everyday purchases and spending, while a line of credit is more for big-ticket items and business expenses. Because of this, the limits vary widely for both options. A line of credit will usually be offered with a higher limit than a normal credit card account, which also means that a line of credit is harder to obtain. Your credit score and history of borrowing will affect whether you can get either of these, but you’ll likely need a very good credit score to access a line of credit.[2]

Credit cards are considered unsecured loans, as there’s no collateral involved. Lines of credit can also be unsecured, but there are secured lines of credit called “Home Equity Lines of Credit” which are backed by the value of your home. This means if you’re unable to pay, the financial institution is allowed to sell your home to make back their money.[1]

Another key difference between a line of credit and credit cards is that credit cards usually have 0% APR introductory offers for a specified amount of time, while a line of credit will probably not have any such offer. Credit cards also typically come with a rewards program based on the provider, and it’s rare to find a line of credit with a rewards program.[2]

Credit cards and lines of credit each come with a wide range of terms and options. Knowing the differences and similarities between these two products can save you a lot of time and money. We recommend doing a fair amount of research before committing to either of these products. Read the fine print, do your homework, and you’ll find the right product for your lifestyle and financial situation.

Read the other parts of our Give Me Some Credit series:


References

  1. Simpson, Stephen D. “The Basics of Lines of Credit” Accessed August 1, 2016. www.investopedia.com/articles/personal-finance/072913/basics-lines-credit.asp
  2. YKiernan, John “Line of Credit vs. Credit Card: Difference, Cost” Accessed August 1, 2016. https://https://www.investopedia.com/articles/personal-finance/072913/basics-lines-credit.asp

Give Me Some Credit: The Risks and Rewards (2 of 3)

CC1 (risk)

Having a credit card in 2016 feels like a necessity. The majority of Americans carry and use credit cards on a regular basis. Purchases range from everyday items like groceries, to vacations and expensive home appliances. However, just because they’re widely used doesn’t mean credit is 100% safe. In fact, if you aren’t aware of best practices prior to spending, you may find yourself with “bad credit“, burdened with more debt than you can handle, or both.

The Risks

Too many cards

Most of us have received credit card offers in the mail, but you shouldn’t accept every offer you receive. Especially with credit cards.

Carrying multiple credit cards is like asking to be in debt. It’s difficult to manage several balances on many different cards. Additionally, depending on the card, you may be subject to annual fees, which add up quickly. You also run the risk of damaging your credit and your ability to borrow in the future. Transferring balances does not rid you of debt, it simply changes your terms, conditions, and (in some cases) your Annual Percentage Rate (APR). Carrying one or two credit cards will be easier to manage, monitor, and pay off.[1]

Maxing out your card

Spending up to your credit limit will lead to a lower credit score, which can damage your financial future. When determining your score, Fair Isaac Company (FICO) will look at how much credit is available to you, and how much of that you’re using. This is referred to as your “utilization ratio” which is a fancy way of saying the amount of credit you’re using. The less credit you need, the better. People with a high credit utilization ratio will have a lower credit score and may have other financial difficulties.[2] Utilization ratios are like golf — lower is better.

Minimum payments

Credit cards make people feel like they can purchase things they can’t actually afford. The idea of buying something now without having cash on hand is pretty appealing. This causes people to rack up high balances on their cards, then only make minimum payments because that’s all they can afford. This allows the interest to build and leads to being in debt for a longer amount of time (read more in What You Should Know About Interest Rates).

By not carrying a balance on your credit card, you’re ensuring that you’ll pay little-to-no interest, and you’ll keep that utilization ratio low.[1] Check out this minimum payment calculator to see how paying the minimum will really effect you.

Cash advances

Taking out a cash advance through your credit card is not a safe option for quick cash. The average interest rate for a credit card cash advance is about 8.5% higher than the normal purchase interest rate. In addition, the interest on a cash advance will start accruing immediately, whereas with a regular credit card purchase there’s typically a grace period. It may be an easy option, but it could cost you big time.[2]

The Rewards

Rewards programs

Most credit cards today offer benefits and perks to customers. Some offer airline miles based on your purchases, while others may offer 0% interest for a specified time period after you sign up. Most cards also provide cash back rewards programs — your purchases are worth points which can be redeemed for cash. It may take some shopping around to find the rewards program that fits your lifestyle. If you travel a lot, you may want a card that provides airline miles. If not, find a card with a good introductory rate so you don’t have to pay interest for a little while.

Build your credit score

When used correctly, credit cards can actually help boost your credit score. Making payments on time and maintaining a very low balance (or no balance at all) will look good on your credit report and over time could raise your credit score, leading to better options for cards and loans in the future.[3]

Easy to monitor

Credit cards make tracking your spending simple and convenient. Paying with cash can make it difficult to track your spending patterns, but with a credit card you can access all your transactions online in a few seconds. Pay close attention to your charges and transactions so you can easily spot credit card fraud.

Credit cards can be a useful tool when used correctly. Abusing the power of credit cards however, can lead to deep financial issues that take years to solve. Make sure you know what you’re getting into before you decide to use your credit card.

Note: If you’re regularly maxing out your credit cards, or getting denied additional credit, you may consider a personal loan to help get you the cash you need. OppLoans personal installment loans can actually help solve that problem in more ways than one: OppLoans reports on-time payments to credit bureaus which means you not only get the money you need now, but you can actually rebuild your credit over time. Give us a call today at (800) 990-9130 or click “Apply Online” below to find out more!

Read the other parts of our Give Me Some Credit series:


References

  1. Bell, Kay. “10 Worst Credit Card Mistakes” Accessed July 26, 2016. https://www.creditcards.com/credit-card-news/help/worst-credit-card-mistakes-6000.php
  2. Peterson, Lars. “7 Dangerous Credit Card Mistakes You’re Making” Accessed July 26, 2016. https://money.usnews.com/money/blogs/my-money/2015/07/16/7-dangerous-credit-card-mistakes-youre-making
  3. Yuille, Brigitte. “Credit Cards: Pros and Cons” Accessed July 26, 2016. https://www.investopedia.com/university/credit-cards/credit-cards6.asp

FICO Score

FICO Score
A FICO score is a credit score developed by the FICO company. These scores are created using information from a person’s credit report about their history of using credit and managing debt.

What is a FICO score?

The FICO score was created by Fair, Isaac & Company in 1989. (Their name was shortened to FICO in 2003.) FICO scores are used by lenders to help predict a borrower’s behavior and assess their creditworthiness. Lenders can use a borrower’s FICO score to determine whether they are likely or not to pay their bills on time and how much credit they will be able to handle. Scores developed by FICO can also be used to forecast if a specific borrower’s account could end up included in a bankruptcy filing.[1]

While there are other kinds of credit scores in addition to FICO, most lenders still use FICO scores when deciding whether to offer you a loan or credit card. They will also take your score into account when deciding the terms of your loan, especially the interest rate. Banks may also use FICO scores when approving checking and savings account applications and setting the terms of those accounts.[2]

FICO scores range anywhere between 300 and 850; and the higher the number, the better with a score. While any loan carries risk for both the borrower and the lender, borrowers with high FICO scores are considered by lenders to be a relatively safe bet. For borrowers, that high score translates into more loan approval, lower interest rates, higher maximum limits, and more favorable terms.

How do I know if I have a good FICO score?

Basically, if you have a FICO score that’s 680 or above, you have a good score. And if you have a score that is 720 or above, you have a great score. While these ranges are not 100% official, here are the five basic tiers:

RangeQuality
720-850Great Credit
680-719Good Credit
630-679Fair Credit
550-629Subprime Credit
300-549Poor Credit

How are FICO Scores created?

FICO scores are based on the information collected by the three major credit bureaus : Equifax, Experian, and TransUnion. This information is put together into a document called a credit report. The report tracks a person’s history of credit use over the past seven years. It includes information their payment history, their amounts owed (both past and present), the length of their credit history, their recent credit inquiries, and their mix of different credit types.

When FICO creates a person’s credit score, they weight some of these factors more heavily than others. The breakdown looks a little something like this:

Payment History — 35%: Does a person have a good track record of making their payments on time? This category also includes information on whether or a not a person has ever had an unpaid account sent to a debt collector.

Amounts Owed — 30%: This looks at how much debt a person currently has outstanding. It also takes into account how much credit a person has used in relation to the maximum amount they have available.

Length of Credit History — 15%: How long has a person been using credit? All other factors being equal, a longer history is generally better.

Credit Mix — 10%: This factor takes into account the different kinds of credit that a person uses: from personal, auto and home loans to credit cards, student loans and lines of credit.

New Credit Inquiries — 10%: This category includes any requests for new credit that a person has made. Generally, too many credit inquiries in a short period of time is seen as a red flag.[3]

Is the information on my credit report always correct?

No. Credit reports can and do contain errors or false information, like a collections account that was settled but is still being reported as open. It’s always a good idea to check your credit report personally to make sure that all the information on it is correct. If you find an error, you can dispute it with the appropriate credit bureau.[1] Under federal law, each bureau is required to provide each individual with one free copy of their credit report per year. However, they will only provide the report if you request it. To request a free copy of your credit report, just visit AnnualCreditReport.com.

It’s also important to know that the data on a person’s credit report can vary depending on which credit bureau has produced the report. This means that your FICO score could also vary from one credit bureau to another. FICO also has different variations on its basic scoring model, which are tailored to different types of lenders. This means that if you are applying for a mortgage or car loan, your score might be different than it would be if you were applying for a credit card. A borrower could have several different FICO scores, even if they are all calculated from the same credit agency’s data.[3]

How can I figure out my FICO score?

There are four main ways a borrower can check their FICO score. First, borrowers can check their credit card or loan statement.  Many major credit card companies and some auto loan companies have begun to provide FICO scores for all their customers on a monthly basis.[4] Second, a non-profit credit counselor can provide a borrower with a free credit report and FICO score. Not only that, but they can help people interpret their score and the information contained their credit report.

Third, a borrower can use one of the many websites that have an offer for a “free credit score.” Some of these sites are funded through advertising and not charge a fee. Other sites may require that you sign up for a credit monitoring service with a monthly subscription fee in order to get your “free” score.[4] Lastly, you can buy your score directly from one of the three main credit reporting companies or from FICO themselves.

What can I do to change my FICO score?

If you have a lower credit score, it is often referred to as having “bad credit.” This can prevent lenders from giving you a loan or credit card. However, it is possible to change your credit score.

Re-establishing your ability to make a payment on time, only applying for credit that you actually need, not using too much of the credit that is available to you, and checking your credit score once a year are all ways to boost and maintain a higher credit score. In the long term, that higher score will help you get approved for better loans and credit cards, with lower rates and better terms. FICO and credit scores can change over time based on your credit behavior; taking control of what matters is key.

References:

  1. “What is a FICO Score?” Accessed July 16, 2016 Credit.com
  2. “What’s in Your Score?” Accessed July 16, 2016 MyFICO.com
  3. “What is a FICO Score?” Accessed July 16, 2016 ConsumerFinance.gov
  4. “Where Can I get my FICO Score?” Accessed July 15, 2016 ConsumerFinance.gov

Credit History

Credit History
A borrower’s credit history is a complete record of how well they have managed their debts. This information is collected and organized in their credit report.

What is Credit History?

A borrower’s credit history is a complete record of how they have managed their debts. Your credit history includes how many accounts you have, how long each account has been open, total amount of available credit that’s been used, whether or not payments are made on time, and the number of recent credit inquiries.[1] This information is then collected into a document called a credit report.

What is a credit report?

Credit reports are collected and maintained by credit bureaus, also known as credit reporting agencies. The credit bureaus then sell those credit reports for a fee to lenders. Lenders and financial institutions use these reports to decide whether or not to grant a loan to an individual.[2] They use credit reports and credit scores, which are based on credit reports, to determine if a potential borrower is creditworthy. In the United States, there are three major credit bureaus: Equifax, Experian and TransUnion.[3]

What is a credit score?

A person’s credit score is basically a numerical grade that indicates whether or not they are creditworthy. The most common type of credit score is the FICO score, which was created in 1989 by Fair, Isaac & Company. (The company changed their name to FICO in 2003.) The FICO score uses a scale from 300 to 850; 300 is the lowest (or worst) score, and 850 is the highest (or best).

How is my Credit History used to determine my credit score?

A FICO score is based on the information found in a person’s credit report. The scoring process weights some factors as more important than others. According to FICO’s website,[4] the score is weighted like so:

Payment History35%
Amounts Owed30%
Length of Credit History15%
Credit Mix10%
New Credit Inquiries10%

There are many different factors in a person’s credit history that can impact their credit score. The most important factors in determining your credit history are your history of making payments on time, and how much debt you currently owe. It is also important that a person not have used too much of the credit available to them. This means that maxing out your credit cards will hurt your credit score.

When it comes to the length of a person’s credit history, longer is generally better. If you have just recently started using credit, it could take a while for your credit score to improve. Credit mix is another factor; credit mix means the variety of different types of debt that you carry like student loans, mortgages, credit cards, etc. A diverse mix is generally preferred. Lastly, your credit score takes into account whether you have any recent credit inquiries (which are discussed below in more detail).

How can my Credit History hurt or help my credit score?

A notice of debt collection will always negatively affect a person’s credit score. These are unpaid, past-due accounts that have been sent to a third-party collection agency. These are businesses that contact borrowers and urge them, often unpleasantly, to pay what they owe. Some debt collectors are known for their aggressive, borderline-illegal tactics.[5] Depending on the size of the debt, a debt collector can even take a person to court and have their wages garnished. When a bill or account has been sent to collections it is seen on your credit report as a derogatory mark.

One factor that can positively affect an individual’s credit score, and overall creditworthiness, is the average age of their open credit lines. Basically, the longer you have a well-managed credit line, the better it looks to potential lenders. If a borrower has a credit card and has been able to make every payment on it for several years, they have demonstrated that they are a responsible borrower.[6]

A person’s credit history not only contains the total number of accounts they currently have open, it also includes any past or closed accounts that they have had in the past seven years. These accounts include ever type of debt: credit cards, personal loans, auto and student loans, and mortgages. Having multiple, well-maintained lines of credit in their credit history will positively impact a person’s credit score. However, it’s typically not recommended to open several new lines of credit simply to increase your total number of credit accounts.

The number of hard inquiries made to your credit history can also affect your credit score.

What is a credit inquiry and how can it affect my credit score?

There are two kinds of inquiries that can occur on your credit report: hard inquiries and soft inquiries. While both types of credit inquiries enable a third party, such as you or a lender, to view your credit report, only hard inquiries can negatively affect your credit score.

These inquiries occur when a financial institution checks a borrower’s credit in order to decide whether or not to approve them for a loan or line of credit. A hard inquiry may occur when you apply for any of the following: auto loan, student loan, business loan, personal loan, credit card, or a mortgage.

The other type of inquiry that can happen on your credit report is a soft inquiry. These type of inquiries occur whenever a person or company checks a borrower’s credit report as part of a background check. They also occur when a person is pre-approved for a credit card offer or when a person is checking their own credit score. Soft inquiries can occur without your permission, but they will not affect your credit score.

A person’s credit score is usually penalized when several hard inquiries occur within a short period of time. Frequent applications often indicate a borrower who is desperate for credit, and thus, is unlikely to be creditworthy. While one hard inquiry might knock a few points off a credit score (if any), multiple hard inquiries in a short amount of time may cause significant damage.

How can I improve my Credit History or my credit score?

Your credit history and credit score can both be improved over time by making regular on-time payments. Changing spending, repayment, or budgeting behavior is a critical first step to rebuilding credit history. With consistent effort over time, your credit history will reflect a more creditworthy borrower.

References:

  1. “Credit History”. Accessed July 12, 2016 Investopedia.com
  2. “What is a Credit Bureau?” Accessed July 12, 2016 https://www.investopedia.com/terms/c/creditbureau.asp
  3. “What is a credit report?” Accessed July 12, 2016 https://www.investopedia.com/terms/c/creditbureau.asp
  4. “What is my FICO Score?” Accessed July 12, 2016 https://www.myfico.com/crediteducation/whatsinyourscore.aspx
  5. “What is Debt Collection?” Accessed July 12, 2016 https://credit.about.com/od/debtcollection/a/whatcollection.htm
  6. “What is a Credit Score?” Accessed July 12, 2016 https://www.creditkarma.com/article/credit-score-factors

The “Interest rate” is the price of money. In other words, an interest rate is the amount that a lender charges to loan out money—it’s designed to be high enough to cover the risk and fees involved in making a loan. Certain loans have very low risk and thus very low interest rates, like mortgages. Personal loans to people with low credit ratings have more risk, so they tend to have higher rates.

Like any price, sometimes the amount you pay is worth the services you receive, and sometimes it is not.

What is APR?

Interest rates are usually expressed as annual percentage rates (APR). This is the rate you would pay if you borrowed money for an entire year, without paying any of it back.

Let’s look at how it works with a payday loan. You pay $15 to borrow $100 for two weeks—an interest rate of 15%. That’s not the annual percentage rate, though. APR is the interest calculated over a full year.

And, if you don’t repay any part of the loan, the amount owed can become huge. Let’s suppose you take out a payday loan with a 15% fee on the first of the year. You roll it over every two weeks without paying off any of the amount borrowed. Look how quickly the total amount grows: in two months, you owe more money than you borrowed.

 

Initial Amount Borrowed

Fee

Total Amount Owed

Total Interest Owed

January 1, 2016

$100.00

$15.00

$115.00

$15.00

January 14, 2016

 

$17.25

$132.25

$32.25

January 28, 2016

 

$19.84

$152.09

$52.09

February 11, 2016

 

$22.81

 $174.90

$74.90

February 25, 2016

 

$26.24

 $201.14

$101.14

March 10, 2016

 

$30.17

 $231.31

$131.31

March 24, 2016

 

$34.70

 $266.00

$166.00

April 7, 2016

 

$39.90

 $305.90

$205.90

 

What happens is that you are charged interest on outstanding interest. It’s a phenomenon called compound interest, and it is incredibly powerful. Or, as the bankers like to say, those who do not understand compound interest are doomed to pay it.

Buy the numbers

In almost all states, the interest rate on a loan must be quoted as the annual percentage rate (APR) to help you compare the rates being offered by different lenders. The equation used to calculate it is:

(1 + r)t = 1 + APR

It’s not as hard to calculate as it might seem. The r in the equation is the interest rate charged each period, written as a decimal, and t is the number of time periods in a year. So, if the interest rate were 3% a month, you would find the APR to be 42.58%.

The problem is that some lenders charge rates that are well above what they need to make to offset their risk. The payday loan, with 15% interest charged every two weeks, has a huge APR:

(1 + .15)26 = 1 + 36.76

That number, by the way, is 3,676%. Yikes!

Usury is the practice of charging excessive rates of interest. It is outlawed in many states, but not all. Even states that regulate interest set a maximum rate, but some lenders charge less. That’s why it’s pays to shop around.

Now, the compound interest calculation assumes that you can roll the loan over every two weeks without paying off even part of the principal, and that’s not going to happen. One way to reduce the total amount of interest paid is to make regular payments of both principal and interest.

Build a better credit score

The other way to reduce the amount of interest paid is to build a better credit score. That reduces the risk to the lender, which means that the rate charged will be less.

One way to build your credit is to make regular, on-time payments on your debts. If you take out a personal loan, make sure the lender reports on-time payments to credit unions, this can help build (or repair) your credit. 

Understanding interest rates can help you make smarter financial decisions in the long run. It’s information that you can use to improve your financial future.

Why OppLoans

OppLoans is the nation’s leading socially-responsible online lender and one of the fastest-growing organizations in the FinTech space today. Embracing a character-driven approach to modern finance, we emphatically believe all borrowers deserve a dignified alternative to payday lending. Currently rated 5/5 stars on Google and LendingTree, OppLoans is redefining online lending through caring service for our customers.

The “Interest rate” is the price of money. In other words, an interest rate is the amount that a lender charges to loan out money—it’s designed to be high enough to cover the risk and fees involved in making a loan. Certain loans have very low risk and thus very low interest rates, like mortgages. Personal loans to people with low credit ratings have more risk, so they tend to have higher rates.

Like any price, sometimes the amount you pay is worth the services you receive, and sometimes it is not.

What is APR?

Interest rates are usually expressed as annual percentage rates (APR). This is the rate you would pay if you borrowed money for an entire year, without paying any of it back.

Let’s look at how it works with a payday loan. You pay $15 to borrow $100 for two weeks—an interest rate of 15%. That’s not the annual percentage rate, though. APR is the interest calculated over a full year.

And, if you don’t repay any part of the loan, the amount owed can become huge. Let’s suppose you take out a payday loan with a 15% fee on the first of the year. You roll it over every two weeks without paying off any of the amount borrowed. Look how quickly the total amount grows: in two months, you owe more money than you borrowed.

 

Initial Amount Borrowed

Fee

Total Amount Owed

Total Interest Owed

January 1, 2016

$100.00

$15.00

$115.00

$15.00

January 14, 2016

 

$17.25

$132.25

$32.25

January 28, 2016

 

$19.84

$152.09

$52.09

February 11, 2016

 

$22.81

 $174.90

$74.90

February 25, 2016

 

$26.24

 $201.14

$101.14

March 10, 2016

 

$30.17

 $231.31

$131.31

March 24, 2016

 

$34.70

 $266.00

$166.00

April 7, 2016

 

$39.90

 $305.90

$205.90

 

What happens is that you are charged interest on outstanding interest. It’s a phenomenon called compound interest, and it is incredibly powerful. Or, as the bankers like to say, those who do not understand compound interest are doomed to pay it.

Buy the numbers

In almost all states, the interest rate on a loan must be quoted as the annual percentage rate (APR) to help you compare the rates being offered by different lenders. The equation used to calculate it is:

(1 + r)t = 1 + APR

It’s not as hard to calculate as it might seem. The r in the equation is the interest rate charged each period, written as a decimal, and t is the number of time periods in a year. So, if the interest rate were 3% a month, you would find the APR to be 42.58%.

The problem is that some lenders charge rates that are well above what they need to make to offset their risk. The payday loan, with 15% interest charged every two weeks, has a huge APR:

(1 + .15)26 = 1 + 36.76

That number, by the way, is 3,676%. Yikes!

Usury is the practice of charging excessive rates of interest. It is outlawed in many states, but not all. Even states that regulate interest set a maximum rate, but some lenders charge less. That’s why it’s pays to shop around.

Now, the compound interest calculation assumes that you can roll the loan over every two weeks without paying off even part of the principal, and that’s not going to happen. One way to reduce the total amount of interest paid is to make regular payments of both principal and interest.

Build a better credit score

The other way to reduce the amount of interest paid is to build a better credit score. That reduces the risk to the lender, which means that the rate charged will be less.

One way to build your credit is to make regular, on-time payments on your debts. If you take out a personal loan, make sure the lender reports on-time payments to credit unions, this can help build (or repair) your credit. 

Understanding interest rates can help you make smarter financial decisions in the long run. It’s information that you can use to improve your financial future.

Why OppLoans

OppLoans is the nation’s leading socially-responsible online lender and one of the fastest-growing organizations in the FinTech space today. Embracing a character-driven approach to modern finance, we emphatically believe all borrowers deserve a dignified alternative to payday lending. Currently rated 5/5 stars on Google and LendingTree, OppLoans is redefining online lending through caring service for our customers.

A Crash Course in Credit Card Cash Advances (1 of 3): The Basics

CCC The Basics

Tough times happen. When money gets tight, some people will turn to credit card cash advances to get by, but the dangers often far outweigh the benefits. Here’s everything you need to know to prep for a financial challenge.

Credit card cash advances can seem helpful because they’re fast, but you’ll often find that the long-term results are dangerous amounts of debt, mounting fees, and worsening spending habits. Protect your money and your credit by taking the OppLoans Crash Course in Credit Card Cash Advances.

What is a Credit Card Cash Advance?

People regularly use credit cards for daily purchases or big-ticket items like appliances, car repairs, or other big surprise expenses. Knowing how to use a credit card responsibly can provide you with options you might not normally have. For instance, say your computer crashes unexpectedly. You may not have enough cash on hand for a new one right now, but a credit card allows you to make that purchase and pay it off over time.

Making payments on time even helps build your credit score (resulting in a higher credit limit).

You can also use your credit card to withdraw cash. This is similar to taking out cash at the ATM or some retailers using a debit card, but the money doesn’t come from your checking account, it comes out of your credit limit–which is, technically, money you don’t have yet. Essentially, you’re taking out a short-term, small-dollar loan. This is a credit card cash advance.[1] It seems easy … almost too easy.

How Does It Work?

Well, it may seem obvious, but the first thing you’ll need to obtain a credit card cash advance is … a credit card (crazy, we know). There are a few different methods for obtaining a cash advance from your credit card provider. You can withdraw cash from an ATM the same way you would with a debit or check card. In order to do this, you’ll need to have a PIN number set up through the card provider. If you don’t have a PIN, you’ll need to contact the credit card company to set it up (read more in What You Should Know About Cash Advance Loans: An interview with financial expert Ann Logue).

You can also withdraw money from a bank teller. This may be wiser than using an ATM, as a bank teller can answer any questions you may have about the transaction and the fees. Some banks may even charge less for withdrawing money from a teller. Make sure to ask questions and know what fees and charges you’re agreeing to prior to receiving your advance.

Convenience checks can also be used to collect a cash advance. These are similar to standard checks, but they’re associated with your credit card account instead of your checking or savings account. Companies will occasionally mail these to customers along with special offers like 0% APR for a limited time.[2]

How Much Can You Get?

The amount you can withdraw will vary depending on several factors. First, it will depend on the cash advance limit set by your credit card company. It will also depend on your credit standing. If you have a low credit score, you may not be eligible for a high credit limit. With a good credit score, your credit limit for both purchase transactions and cash advances will be higher. Make sure you know your credit limit, because maxing out a credit card will negatively impact your credit score. Odds are you’re not going to get very much with a credit card cash advance. When you add up all the risks, the low advance amount often doesn’t make these risky maneuvers worth it. Learn more about the risks in The Hidden Dangers of Cash Advances.

The most important thing to remember is to ask questions. If you’re unclear about how something works or how much you should withdraw, even about whether you should even get a credit card cash advance at all—ask questions. Do your research and make sure that you’re making the best decision for your financial future.

True or False: Credit Card Cash Advances are a Risky Choice

This is an easy one. Borrowing against money you don’t have is always a gamble.

If you’re looking for a safer way to borrow, consider a personal installment loan from OppLoans. Our loans have longer terms (up to 36 months), more flexible repayment plans, and we report on-time repayments to build your credit. Click “Apply Online” below to get started today, and congrats on skipping that dangerous credit card cash advance. We knew you were too smart for that!

References:

[1]Konsko, Lindsay “What is A Cash Advance?”NerdWallet.com Accessed May 13, 2016.

[2]“What is a Credit Card Cash Advance?”ValuePenguin.com Accessed May 13, 2016.

A Better Beach Read: 5 Tips to Improve Your Credit

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Ah, the joys of summer: grilling in the backyard, watching the world burn in the latest Hollywood blockbuster, and, of course, the beach. It’s the time of year to kick back, put your feet up, and chill the heck out. But if you’re dealing with financial troubles, you might have a hard time relaxing.

Those high credit card payments, past due bills, and denied loan applications can loom over you like a storm cloud. Rather than wallow in doom and gloom, why not tackle those financial problems head on? We’ll even help you out by giving you this simple piece of advice: focus on your credit score. Now might be the time to set aside that light-and-fluffy beach read and check out these five tips for repairing your credit.

Get a Copy of Your Credit Report

Before you can fix your credit score, you have to know what’s in your credit report. It’s what your credit score is based on, and it tracks your history of credit-use over the past seven years.

A copy of your credit report will help you see what exactly is dragging your score down into the dumps. Plus, credit reports aren’t perfect; some will contain errors. If you find an error on your credit report, you can contact the appropriate credit bureau—Experian, TransUnion, or Equifax—to get it corrected. Learn more in the blog Grading Your Credit Score.

Under federal law, each credit bureau is required to provide you one free credit report per year—but only if you request it. To order a free copy of your credit report, visit www.AnnualCreditReport.com.

Get Current and Stay Current

This is a two-parter that includes your ongoing bills and your outstanding collection notices.

If you have any outstanding collection notices, you’ll want to get them taken care of ASAP. A closed collection will still show up on your credit report for up to seven years, but it’s much better than an open one.

If you have trouble paying your bills on time, try setting reminders or setting certain bills to auto pay. Paying bills on time is one of the easiest steps you can take towards improving your credit while paying bills late is one of the easiest ways to hurt it.

Pay Down Your Credit Card Debt

Easier said than done, right? Still, if you’re looking for ways to boost your credit score, focusing on paying down your credit card debt is a great way to go. Having high amounts of credit card debt can really hurt your score. The sooner you can lower those balances, the better.

How exactly are you going to do this? Well, it’s probably going to require some belt-tightening. If you already have a household budget, then give it an honest look and see where you can cut back. If you don’t have a budget: create one. There are a ton of great apps available that make budgeting easier than it’s ever been. Find money where you can and use it to pay off your cards. You might even try increasing your income through a side gig or selling unused valuables.

Keep Old Accounts Open, Don’t Open New Ones

One measure used to determine your credit score is how much of your available credit you’re actually using. If you have a credit card with $5,000 limit and you’ve only used $2,000, that’s seen as more responsible than having a card with a $2,000 limit that you’ve maxed out.

Once you’ve paid off your old credit cards, you might be tempted to close out the accounts. Don’t! Keep the accounts open and don’t use them. This will help your credit score.

On the other hand, if you’re thinking of opening up a bunch of new cards to take advantage of the extra unused credit, we advise against that. Recent credit inquiries are one of the factors on your score. A bunch of new credit lines could result in your credit score going down.

Be Patient

There is no one-and-done solution for fixing your credit score. It’s not going to shoot up 100 points overnight. So take a deep breath, settle in, and prepare yourself mentally for the long game. Even if you start making more informed decisions today, it could take up to seven years for your previous not-so-good choices to stop affecting your score.

In the meantime, as long as you’re checking your credit report, making payments on time, paying down your credit card debt, and using less credit than what you have available, you are well on the road to a higher score and sunny financial future.

At OppLoans, we help improve our customers credit scores by reporting their on-time payments to credit bureaus. Taking out a safe, lower-interest, personal loan with OppLoans is one action you can take now to get started on the road to financial recovery. Click “Apply Online” below to get started today.

Now that you’re on your way to improved credit, go ahead and unwind at the beach! You’ve earned it.

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Climb Your Way Out of Debt: 6 Paths You Can Take Today

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If you owe money, you are not alone—in fact, you are part of the overwhelming majority. It’s estimated that eight out of ten Americans are in debt![1]

Whether you’re burdened with credit card debt, student loans, car payments, a mortgage, or any other kind of debt—there are ways to manage it and eventually get out of debt completely. Here are six different strategies you can adopt today to climb out of debt.

Debt Consolidation Loans

Maybe you’re making monthly payments on several different outstanding debts and it’s becoming too much to manage. A debt consolidation loan might be right for you.

A debt consolidation loan means taking out one loan in order to pay off several debts. This new loan simplifies payments; the borrower will now only have one payment to make each month, rather than several. You’ll then make fixed, monthly payments on the new loan until it’s completely paid off. Ideally, this loan will also provide the borrower with lower monthly payments, a lower interest rate, or both.

A debt consolidation loan should be carefully considered, however, because while it will provide you more convenience, it can end up costing you more money. These loans don’t always mean lower monthly payments and interest rates.

Another way to consolidate debt is through credit card debt consolidation.

Many credit card companies allow customers to transfer debt into one account. Like a debt consolidation loan, this simplifies your payment process. This will likely lower your payments, but there is typically a fee. Additionally, it’s important to read the fine print, because the lower interest rates are often only for a limited time. These low-interest credit cards are typically only available to people with good credit.

Debt Management Plans

Another way to deal with debt is through a Debt Management Plan (DMP). Basically, DMPs require that the borrower comes to an agreement with the lender. This agreement details how the debt will be repaid. This arrangement is usually for a term longer than the original repayment schedule.[2] Learn more about debt management plans in the article Debt Consolidation: A Small Solution to a Big Problem.

Most debt management plans are reached through credit counseling services or nonprofits. These credit counseling agencies will negotiate with your creditors on your behalf. Their goal is to lower your monthly payments and have your late fees and penalties waived.[3]

Companies that offer debt management plans often have relationships with banks and credit card companies, which will go a long way in making sure that your interest rates will be lowered so that you can repay what you owe.

But there can be drawbacks to using this method. In addition to having you consolidate all of your payments into one, DMPs will often have you close your credit cards which could affect your credit score. You’ll also see a “DMP” notation appear on your credit report.[4] It’s important to do your research before agreeing to a DMP because the Federal Trade Commission has found that some companies that offer DMPs are out to defraud customers.[5] Should you decide on a debt management plan, you will pay money directly to a credit counseling service, they will then make payments to your various creditors.

According to a recent survey, debt management programs cost the average borrower $24 per month. In addition, most plans require an enrollment fee at the beginning of the plan, but that extra money may be well spent if you save on interest and late fees.[6]

Debt Snowball Method

The debt snowball method helps you prioritize your debts. Simply put, you start by paying off the debt with the lowest outstanding balance. Once that debt is paid off, you move on to the debt with the next lowest outstanding balance, and so on until all of your debts are paid off.

Any amount that was going toward a minimum monthly payment is applied toward the next debt once the first is paid off.

Creating a budget and cutting back wherever possible is also crucial since it will free up funds that can go toward paying down your debts.

Like a snowball rolling down a mountain, the Debt Snowball builds momentum. Because you pay off your smallest debt relatively quickly, it can give you the psychological boost you need to keep going and pay off all of your debts. The drawback to the debt snowball method, though, is that you may end up paying more in interest over time because it focuses on paying off the outstanding principal rather than taking into account the interest being accrued on that principal.

Read more about Debt Snowballs in our Financial Smarts Glossary here.

Debt Avalanche

Debt avalanche is similar to the debt snowball method, but the difference is you pay off the debt with the highest interest rate first and the debt with the lowest interest rate last. This method will likely take longer, though. However, debt avalanche, or debt stacking as it’s also known, often results in the borrower paying less in interest in the long run. This is because they borrowers are paying off the most costly debt first. With the highest interest debt being paid off first, the debt that is left over is accruing less interest, and therefore costs the borrower less money.

Bankruptcy

Bankruptcy is often the last resort for people and businesses who are overcome with debt.
There are three kinds of bankruptcies that individuals and businesses in the US can file for: Chapter 7 (lenders seize assets and sell them to recoup their funds), Chapter 11 (usually filed by businesses, and involves them reorganizing business affairs and assets), and Chapter 13 (requires that the debtor submit a plan for repayment, usually within a few years).

Though bankruptcy is an option, it shouldn’t be entered into lightly. Once you file for bankruptcy, it can negatively impact your credit score for 10 years. This can hurt your chances of taking out a loan, getting a job, or even finding a place to live.[7]

A Better Personal Loan

If you’re one of the millions of Americans with multiple debts and you need to consolidate, consider a personal installment loan with OppLoans. We offer loans that range from $1,000 to $10,000 with reasonable interest rates and repayment terms anywhere from 6-36 months.

Consolidate your high interest debts with OppLoans. Our rates are up to 125% lower than other personal lenders and we never charge prepayment fees. Apply online, get approved in minutes, and receive your funds as soon as tomorrow. You can manage your debt and OppLoans can help.

References:

[1] Holland, Kelley. “Eight in Ten American Are in Debt: A Study.” CNBC.com Accessed May 27, 2016.

[2] “Debt Management Plans Explained.” BBC.com Accessed May 27, 2016.

[3] Khalfani-Cox, Lynette. “Debt Management vs. Debt Settlement: Which Is Best?” AARP.org Accessed May 27, 2016.

[4] “What’s the Difference between a Credit Counselor and a Debt Settlement Company.”ConsumerFinance.gov Accessed May 27, 2016.

[5] “For People on Debt Management Plans.” Consumer.FTC.gov Accessed May 27, 2016.

[6] O’Shea, Bev. “How Does Debt Management Work?” NerdWallet.com Accessed May 27, 2016.

[7] “Debt Relief or Bankruptcy?” Consumer.ftc.gov.com Accessed May 27, 2016.