Borrowing money (Loans) Simple version for Eager Learners

Borrowing money or on credit or taking a loan to pay it back later, all these terms refer to the same concept. And in this blog post I am going to break it down for you to understand the deep structure of what happen with borrowing money.

When you are borrowing money from a bank or an institution, you will be borrowing a large portion of money and will divide this into equal parts and pay it back over time with an added fee. This is called the interest on a loan or a credit.

On the opposite side, this is how banks make money. By lending to people and receiving interest on them over time.

There is a "Time value of money" concept involved in the simple money borrowing situation. In other words the Interest you are paying for bank loan (after 1 period) is the value of money over that one period, which you didn't pay until the end of the 1st period. So longer the money stays the higher the time value of money becomes.

It also refers to receiving XX today being equal to receiving YY over periods in the future because of the time value that is taken into account for the money.

For example lets assume you are planning to buy a new Car and you don't have enough money, so you decide to consult a bank as to a potential loan program. For this example lets say you need another $30,000 for the car, that you need from a loan.
Assuming that you met all the criteria the XYZ bank agrees to lend you money at 5% APR.

what is APR?
Annual percentage rate. Now if the bank say you have to pay the $30,000 in 10 years with equal payments of $3000 every year, the APR is the annual interest that will add onto the annual payment. So in this case your interest payment for a year is....

$3000 x 5% = $150

so total payment is $3150 per year.

Important part here is before you accepting the loan and enjoying your hot wheels, you should thoroughly consider whether you can meet these annual payment requirements. Because you can not meet the annual payment with interest, the bank will apply late fees, and that will lead to more other fees before you go "over draft" and into default. So called the "snowball effect".

Little insight: The United States current economy's main cause -- AIG and other big financial institutes failures -- is lending money to individuals and approving them for loans when it seemed from a deep look that they, not in any shape or form, would have been able to meet in the payment requirements in distant future. Yet were approved and the banks now suffer from the imposed-upon defaults.

So in recap, when you borrow money you will be given a certain set period to pay it back with added interest to each period. It is very important to identify whether one can meet the payments sufficiently before accepting a loan.