You may need to be smart to get into college, but what many college students don’t often think about is how much they don’t know about lending, loans and other financial topics – all of which they will become very familiar with soon enough.
Here’s a breakdown of some important lending terms. Share it with the college students and recent grads in your life as a prep course for some of the real-life lessons ahead, or review yourself if you need a refresher.
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One of the most frequently used methods of planning for the future, 401k accounts allow workers to set aside some of their income to be used in retirement. The IRS limits how much workers can put away in a given year, though older workers may be able to take advantage of catch-up provisions with higher annual contribution ceilings.
Collateral
Lenders need to recover investments if borrowers stop paying. It’s why banks and financial firms can repossess vehicles and foreclose on homes – collateral on auto loans and mortgages.
Interest
Interest is the cost incurred by borrowing money. When you open a savings account, for example, the borrower (the bank) often pays you (the lender) back with interest on your deposit, based on current lending rates.
Interest is calculated as a percentage of how much has been borrowed. Credit rating is one of the biggest determinants behind an interest rate. These ratings, generated through credit bureau reports, help a lender gauge how likely a borrower is to repay a debt. Borrowers with higher scores often benefit from lower costs compared with current lending rates, though a fantastic credit rating isn’t a silver bullet. Lenders also place significant weight on a borrower’s ability to pay by examining information such as debt-to-income ratio.
A tip for college students: If you take out student loans and request deferred payments, interest may build until you start making payments.
IRA
Individual retirement accounts are a popular way to plan for the future. Funds from a traditional IRA are taxed upon withdrawal while funds from a Roth IRA are taxed prior to deposit, meaning the funds are tax-free upon withdrawal. Both are subject to annual contribution limits.
Minimum Down: Most loans require a down payment. Minimums vary based on the types of loans, though making larger down payments almost always lowers borrowing costs.
Mortgage
Most people who want to buy a home need money to do so. A mortgage is an agreement between a buyer and lender, and a common lending, loans topic. Lenders agree to give buyers the money they need to purchase property, and borrowers, in turn, agree to repay the loan with interest based on current lending rates at the time of closing. If the borrower fails to make timely payments, lenders can recoup their investment by taking ownership of the property.
There is a lot to consider when looking into a mortgage. The U.S. Consumer Financial Protection Bureau recommends weighing the size of the loan, the interest rate, closing costs, the annual percentage rate, the type of interest rate (fixed or adjustable), the loan term and whether the loan has features like pre-payment penalties.
Pre-Payment Penalties
Most loans, including federal student loans, don’t have fees for paying off loans early. But make sure to check before signing the dotted line of you want to have the ability to pre-pay on loans without incurring extra costs.
Return on Investment
Your return on investment is how much you’ll get back compared with how much you’ve invested. Make sure borrowing money is worth it. College students should research post-graduation incomes in their fields to see if their educational investments are worth the costs.
CD
A certificate of deposit is a dependable investment that’s protected by the Federal Deposit Insurance Corp. and provides a set rate of return after a pre-determined period of time. Typically, the longer the investment period, the higher the return. Some investors purchase CDs with different lengths of maturity to keep their funds liquid, a strategy sometimes called laddering. There are often early withdrawal penalties.
Term
Term is an important part of lending. It’s the length of time it takes to repay loans with minimum payments. Longer terms usually mean lower monthly payments, but higher borrowing costs.
And one final tip for college students – you may qualify for federal student loans with income-based repayment options. If so, you may be able to settle a loan by making minimum payments for a period of time regardless of whether you repay everything you borrowed. Learn more about AAA’s student lending services.
Are there any important terms missing from this story? Let us know in the comments. Click here to learn more about AAA Financial Services.
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