Getting a Loan - The Homer Fund

Personally Evaluating the Deal ExerciseYour financial situation affects your approach to borrowing money. Every borrower needsto evaluate all the costs and terms associated with a potential loan. Borrowers must decideon the best loan product based on their own personal financial situation. For example:Karime wants to borrow $3,000 to buy a car. After paying his bills each month andaccounting for the cost of living, he has exactly $68.50 to put toward a car payment.Lender A offers him a four-year loan at 8 percent with monthly payments of $73.24.Lender B offers him a five-year loan at 12 percent with monthly payments of $65.97.Karime does some basic calculations to evaluate the two offers.Lender ALender BLoan amount $3,000 $3,000Interest rate 8% 12%Time 4 years 5 yearsMonthly payment $73.24 $66.73Total amount of payments $3,515.52 $4,003.80Cost of credit $515.52 $1,003.80What should Karime do?____________________________________________________________________________________________________________________________________________________________________________________________________________________See page 36 for suggested answers.Evaluate the Total Cost of a LoanWhile it is exciting to get approved for a loan and gain access to credit, it is importantto evaluate the costs. It can be deceiving to focus on any one factor that affects theprice of the credit (e.g., interest rate). It is often worthwhile to “shop” for a gooddeal. This involves talking to a number of lenders about the total cost ofborrowing a certain amount of money. Lenders are required by law to disclosethe total cost of a loan. A lender may offer an appealing package from oneperspective, but the total cost of the credit may not be competitive with thatoffered by other lenders. Make sure to talk about all of the costs involved andcalculate the total cost of the credit.Beware of loans with a large balloon payment at the back end. Balloon loans offerlower interest rates for shorter-term financing, usually five, seven, or 10 years. At theend of this term, they require refinancing or paying off the outstanding balance with alump-sum payment. If the original loan does not guarantee a new loan with reasonablerates, the refinanced loan can cost you even more money because of loan fees andthe uncertainty of rates in the future.24