Young couples looking for an infusion of money for a large purchase (a home or car, for example) or to start a business usually approach financial institutions for a loan. While borrowing money can solve short-term money problems, all loans have negative and positive aspects you should be aware of.
TL;DR (Too Long; Didn't Read)
Borrowing money from a financial institutions has the benefit of obtaining necessary cash quickly, but you also need to consider the downsides of interest payments and legal issues if you fail to pay back the loan.
Immediate Infusion of Cash
The main benefit of borrowing money from a financial institution is the ability to obtain a large amount of money quickly. This money can be used for necessary purchases and investments, including investments in your own education. Financial institutions can lend more money than most friends and family members can.
Financial institutions attach interest rates to the principal amount borrowed. An interest rate can either be a positive or a negative. Borrowers with good credit can attain a loan with a lower interest rate. This, in turn, makes the loan less expensive in the long run. Borrowers with poor credit scores can likely only attain a loan at higher interest rates. This can make borrowing money an expensive decision and possibly unattractive as a financial option.
Interest rates also fluctuate. As such, borrowers should watch interest rates to borrow when rates are low. A strong credit score and favorable market interest rates produce a favorable borrowing environment.
How Collateral Works
Collateral is a legal interest, otherwise known as a lien, that a financial institution places on an asset in case you default on your loan. A common form of this interest is the home mortgage. Collateral removes the risks a financial institution takes on when lending out large sums of money (a house mortgage or car loan, for example).
Upon your defaulting, the financial institution takes control of the asset and sells it for a profit to cover any losses. This secures the institution against losses and creates the freedom to lend out larger amounts. Loans backed by collateral, also known as secured loans, offer lower interest rates but present the clear danger of losing your property.
Traditional Banks and Credit Unions
Traditional banks and credit unions offer different benefits to borrowers. Traditional banks offer services to all potential customers. Even though anyone can potentially use the financial services of traditional banks, these financial institutions often offer loans at high interest rates.
Credit unions, on the other hand, are open to specific groups of people, usually people who live in a specific geographical location or those who belong to certain professions. These financial institutions often offer their members lower interest rates, but, unlike a bank, not everyone can become a customer.
Risk of a Lawsuit
Failure to pay your loan can result in a lawsuit being filed against you. This can result in wage garnishment and a negative mark on your record. This is one of the worst possible outcomes, but it's why all borrowers must remain wary and conservative when taking out a loan from a financial institution.
David Montoya is an attorney who graduated from the UCLA School of Law. He also holds a Master of Arts in American Indian studies. Montoya's writings often cover legal topics such as contract law, estate law, family law and business.