Trade-Offs to Consider When Borrowing Money

When you are considering borrowing money from a financial institution, there are trade-offs to consider on the features of a loan before taking one. Here are some of the major features you should take time to look into first:

Term vs. Interest Costs

If you choose long-term financing because you want smaller monthly payments, you should know that the longer term for a loan at a given interest rate, the greater the amount you must pay in interest charges.

Lender Risk vs. Interest Rate

If you prefer taking a loan that requires low fixed payments or only a minimum of down payment, these requirements can increase your cost of borrowing because they create more risk for your lender. If you want to minimize your borrowing costs, you may need to accept conditions that reduce your lender’s risk. And here are possibilities...

  • Variable Interest Rate:

    A variable interest rate is based on fluctuating rates in the banking system, such as the prime rate. With this type of loan, you share the interest rate risks with the lender. Therefore, the lender may offer you a lower initial interest rate than it would with a fixed-rate loan.

  • A Secured Loan:

    If you pledge property or other assets as collateral, you’ll probably receive a lower interest rate on your loan.

  • Down payment:

    Many lenders believe you have a higher chance of repaying a loan if you make a down payment for what you are financing. Doing so may give you a better chance of getting the other favorable terms you want.

  • A Shorter Term:

    The shorter the period of time for which you borrow, the smaller the chance that something will prevent you from repaying and the lower the risk to the lender. Therefore, you may be able to borrow at a lower interest rate if you accept a shorter loan, but your payments will be higher.