Loans and Borrowing
Module: Credit and Debt • Lesson 10
A loan is borrowed money with a fixed repayment plan
Unlike credit cards, loans are installment debt.
You borrow one set amount
You repay it in scheduled payments
Each payment includes principal and interest
There is a defined end date
Loans are structured and predictable, but still costly if interest is high.
How loans work
Principal
The amount you borrow
Example: You borrow $10,000 to buy a car. That is your principal.
Interest
The cost of borrowing, expressed as an annual percentage (APR)
Example: 5% APR means you pay 5% of the principal each year in interest.
Loan term
The length of time to repay the loan
Example: 60 months (5 years), 180 months (15 years), 360 months (30 years).
Monthly payment
Fixed amount paid every month, covering both principal and interest
Example: $189/month on a $10,000 car loan at 5% for 5 years.
Your payment stays the same every month, but the total cost depends on the interest rate and loan term.
Common types of loans
Mortgage
Loan used to buy a home
Typical term:
15-30 years
Interest rate:
3-7%
Secured by:
The house
Note: Mortgages usually require a down payment (often 10-20% of the home price).
Auto loan
Loan used to buy a car
Typical term:
3-7 years
Interest rate:
4-10%
Secured by:
The car
Note: Cars lose value quickly. Avoid long terms or you will owe more than the car is worth.
Student loan
Loan used to pay for education
Typical term:
10-25 years
Interest rate:
3-12%
Secured by:
Nothing (unsecured)
Note: Federal student loans often have better terms than private loans.
Personal loan
General-purpose loan for various needs
Typical term:
1-7 years
Interest rate:
6-36%
Secured by:
Nothing (unsecured)
Warning: Rates vary widely. Only use for true needs, not wants.
Secured vs unsecured loans
Secured
Backed by collateral (an asset the lender can take if you do not pay)
Examples:
- • Mortgage (house)
- • Auto loan (car)
- • Secured credit card (deposit)
Advantages:
- • Lower interest rates
- • Easier to qualify
- • Can borrow more
Risk:
If you default, the lender takes your collateral.
Unsecured
Not backed by collateral (based on creditworthiness alone)
Examples:
- • Personal loans
- • Student loans
- • Credit cards
Advantages:
- • No collateral required
- • Nothing to lose directly
- • Faster approval process
Risk:
Higher interest rates. Harder to qualify. Damages credit if you default.
What makes a loan expensive
High interest rate
Higher APR = More money paid in interest over time
Example: $20,000 car loan over 5 years
At 3% APR:
$1,562 in interest
At 10% APR:
$5,497 in interest
Difference: $3,935 more just from a higher rate
Long loan term
Longer term = Lower monthly payment BUT more total interest paid
Example: $20,000 car loan at 6% APR
3-year term
Monthly payment
$608
Total interest
$1,895
7-year term
Monthly payment
$283
Total interest
$4,009
Lower payment looks affordable, but you pay $2,114 more in interest
Additional fees
Origination fees, processing fees, late fees all add to the total cost
Common fees to watch for:
Origination fee
1-6% of loan amount
Processing fee
$25-$500
Late payment fee
$25-$50 per occurrence
Prepayment penalty
Varies by lender
How to get a good loan
Improve your credit score first
Better credit = Better rates. Wait if your score is low.
Shop around for rates
Compare at least 3-5 lenders. Rates can vary significantly.
Choose the shortest term you can afford
Higher monthly payment, but less interest overall.
Make a larger down payment
Borrow less = Pay less interest. Aim for 20% down on homes, 10-20% on cars.
Read the fine print
Check for hidden fees, prepayment penalties, variable rates.
Avoid predatory lenders
Stay away from payday loans, title loans, and lenders with extremely high rates.
When to avoid borrowing
For things that lose value quickly
Electronics, furniture, vacations, clothes
When you cannot afford the monthly payment
Stretching your budget too thin creates stress and risk
When the interest rate is extremely high
Payday loans (300-400% APR), title loans, rent-to-own
For wants instead of needs
Borrowing for luxury items you do not need
When you have high-interest debt already
Pay off credit cards before taking new loans
If you cannot afford to buy it outright, think carefully about whether you can afford to borrow for it.
Key vocabulary
Principal
The original amount borrowed
Interest
Cost of borrowing money, expressed as APR
Loan term
Length of time to repay the loan
Installment debt
Debt with fixed payments over time
Secured loan
Loan backed by collateral
Unsecured loan
Loan based on creditworthiness alone
Collateral
Asset pledged to secure a loan
Origination fee
Fee charged to process a new loan
Quick recap
Loans are installment debt with fixed repayment schedules
Principal is what you borrow, interest is what you pay to borrow it
Secured loans have collateral, unsecured loans do not
Higher interest rates and longer terms make loans more expensive
Improve credit, shop around, and choose shorter terms
Avoid borrowing for things that lose value quickly
Read all terms and watch for hidden fees
Only borrow what you can truly afford to repay