Loans: What to Look For

Chances are, you'll have to take out some sort of loan during your lifetime. Maybe you already have. Here's some basic guidance on the three phases of dealing with loans: choosing one, repaying it, and (should you need to) refinancing it.

Shopping for a loan
When shopping for a loan, focus on the long-term cost of the loan, not the monthly payment. “Many car dealers or even mortgage lenders will entice borrowers by asking how much they can afford to pay each month,” said FDIC Senior Consumer Affairs Officer Janet Kincaid. “It may be better to pay slightly more money each month, but for a shorter time period, if it means you will be paying less in total interest.” She also said that some people look so much at the monthly payment that they don’t notice certain fees or service charges that are imposed. “You’ve got to look at the full picture before signing a loan agreement, including the APR and provisions of the loan that can increase fees,” Kincaid said.
(Taken from "51 Ways to Save Hundred on Loans and Credit Cards," FDIC Consumer News, Summer 2007.)

Do your research; shop around for the lowest interest rate, though your credit score may determine what interest rates you are offered. If you're looking for an auto loan, there are an abundance of online calculators you can use to compare rates.

As far as school loans, take what you can get (but only if you really need it) from Uncle Sam. Federal Stafford loans will almost always be the best deal. If you're offered subsidized loans, go for it; they won't accrue any interest until you graduate! They also won't accrue interest if you go into deferment after graduation. You can, of course, start paying them off early, but since they're not accruing any interest, you might be better off investing any extra money you save while you're in school (or using it to pay off other interest-bearing debts). Unsubsidized loans start accruing interest as soon as you get them. Still, they generally offer much better rates than private loans and you don't have to start repaying them until six months after you've finished all your schooling—though the sooner you can start paying on these the better since they're accruing compound interest.

With certain types of loans you can avoid unnecessary interest charges if you pay for certain costs out of your own pocket instead of borrowing that money, too. Let’s say you’re getting a new mortgage and you’re offered the chance to add the closing costs to the loan instead of paying them upfront. Sounds good on the surface, but remember that you’re not getting out of paying the closing costs—they’re added to the loan balance, so your monthly payments will increase and you’ll be paying interest on the closing costs.


Repayment
If you can afford to pay off your loans early, do it. You can save interest expense by increasing your monthly payments and/oror choosing a shorter payment term on your loan.

With auto loans, beware the trap of getting “upside down”—owing more on the car than it is worth when you sell or trade it in.

Talk to your banker if you’re having problems repaying a loan. Explain the situation and any unusual circumstances. Many lenders will agree to temporary or permanent reductions in your loan interest rate, monthly payment or other charges. Open communication is key. Again, it helps if you’ve had a clean record in the past.
(Taken from "51 Ways to Save Hundred on Loans and Credit Cards," FDIC Consumer News, Summer 2007.)

Refinancing
Refinancing is paying a loan off “early” with a new, better loan, and it can save you money. But you have to know when refinancing a mortgage makes sense. According to the Consumer Action Handbook published by the Federal Citizen Information Center, “Consider refinancing your mortgage if you can get a rate that is at least one percentage point lower than your existing mortgage rate and if you plan to keep the new mortgage for several years.” Also consider any extra fees in acquiring the new mortgage.

Consider refinancing an auto loan if you expect to make payments for several more years. It may be harder to find a better interest rate because your car has probably depreciated in value. But if the savings from a lower interest rate more than offsets any closing costs, refinancing can make sense. If you have multiple student loans, look into the potential benefits of consolidating them into one new loan at a lower interest rate. Compare the rates, terms and costs. “It may not be worth consolidating if it means losing a good fixed-interest rate, giving up a long grace period before loan payments are due, or running up other costs that would exceed those on your existing loans,” said Sam Frumkin, a Senior Policy Analyst in the FDIC’s Division of Supervision and Consumer Protection.
(Taken from "51 Ways to Save Hundred on Loans and Credit Cards," FDIC Consumer News, Summer 2007.)

Beware Scams
Steer clear of fraudulent or deceptive offers targeting borrowers. Unscrupulous individuals try to lure consumers into questionable, high-cost deals or fraudulent transactions, usually involving new loans or credit cards or offers to help deal with debt problems. Here are some examples:

“Predatory” loans: People from nonbank or home improvement industries may use false or misleading sales tactics to make high-cost loans to consumers in need of cash. Victims who can’t afford the loan may be pressured to refinance. Borrowers who pledge their house as collateral could lose it in a foreclosure. "Payday loans" make up the majority of predatory loans. There is a load of (false) information about predatory loans and the system that supports them at the ironic Predatory Lending Association website.

Credit repair scams: Con artists may promise to erase a bad credit history or make easy loans to people with spotty credit histories. Most charge exorbitant fees or never provide the promised money. Only steady and consistent on-time payments by a consumer can legally repair a credit record.

Mortgage foreclosure frauds: Thieves may contact homeowners at risk of losing their home to foreclosure and propose to help by “paying your mortgage” while you temporarily “rent” your home from them. They then trick you into signing documents that transfer the ownership of the property to the crooks. In other scams, phony companies claiming to be housing counselors offer to negotiate a new loan or perform other services for very high upfront fees and do little or nothing in return.

(Taken from "51 Ways to Save Hundred on Loans and Credit Cards," FDIC Consumer News, Summer 2007.)


Federal Trade Commission's article with more info on recognizing deceptive offers for private student loans

Banking

Bank Accounts
There are two main categories of bank accounts: loan accounts and deposit accounts. The purpose of loan accounts is to hold a debit balance (where the account holder borrows money from the bank), and the purpose of deposit accounts is to hold a credit balance (where the bank "borrows" from the account holder). The type most of us think of when we hear "bank account" is the deposit account; popular types of deposit accounts include savings, checking, and certificates of deposit (or CDs).

Another way to categorize bank accounts is by their function—while some accounts are designed for frequent transactions (transactional accounts), others, such as CDs, are not.

Overdrafts
When a customer withdraws more than the account's available balance, an overdraft occurs. An overdraft, in essence, means the bank is providing credit to the account holder, giving the account a negative balance. If the overdraft is unauthorized (i.e. the account is not a loan account), the bank will normally charge an overdraft fee, often around $30, though if you call and ask nicely, some banks will waive your first overdraft fee, especially if you are a student or if it's your first time overdrafting.

The best thing to do to avoid overdrafts, of course, is to keep close track of all your transactions, and always be sure to keep a "cushion" of at least $50 more than you expect to be withdrawn (both directly and through debit cards, checks, and transfers) just in case you miscalculate. This number should be higher if the majority of your withdrawals are large ones. If you overdraft on your checking account by writing a check for a sum larger than your balance, it could result in a bounced check and additional fees.

They can do this every time you make a charge over the amount in the account. So, say you've got $50 in the account, and you use your debit card once for $60 and once for $10. Your bank can charge you the overdraft fee twice.

Sucks, doesn't it? Which is why you've got to diligently keep track of what's in your account. Write down everything in your balance ledger (or just keep a close eye on the account online). And don't forget to figure in any automatic payments you may have set up--or outstanding checks that haven't been cashed yet.

If you do overdraw, the only thing you can really do is put money in it ASAP (enough to cover the amount you went over plus the fee) so that you don't get charged any more. Some banks will even charge you every day you have a negative balance. If you're lucky and you catch it right away, your deposit might even make it in before the charge applies (but I wouldn't hold my breath).

Most banks offer what they call overdraft protection, or what I call a big fat scam. Some of them are set up like mini insurance policies--you pay a few dollars every month as insurance in case you overdraw, and then if you do, the bank won't charge you. This is often set up as a line of credit--the bank gives you a certain credit limit and if you overdraft, the remaining amount after your account balance hits zero is charged to this line of credit. This is a loan, and you'll have to pay interest on it the same as you would a credit card balance. Also, most banks still charge a fee (albeit a smaller one) every time the line of credit is used (every time you overdraft). Alternatively, some banks charge a monthly fee simply for the line of credit service, whether you use it or not.

Another kind of overdraft protection some banks offer is to link your account to another account at the same bank or to a credit card, so that if you overdraft, the bank can just transfer the required amount from the linked account so that your balance doesn't hit zero. The problem with these programs is that the bank usually charges a transfer fee, which while usually less than an overdraft fee, is still a fee and still sucks.

As far as I'm concerned, these forms of "protection" are hardly worth it when you consider the amount of fees associated with them. Still, it's a good idea to finding out what your bank offers as far as these programs; it's possible they might offer a good deal--but your best bet is probably just to be careful and make sure you keep a little padding in your account.

See also: credit unions, CDs, savings accounts, checking accounts

A Macro Perspective: Student Loan Relief? For Some.

Image by anne.oeldorfhirsch via Flickr

More and more students are borrowing for college and graduate school, and most everyone knows that in recent years the prices have been rising. But I didn’t know by how much. Turns out that "In the past five years, tuition and fees at public universities have risen by 57%."¹ That’s with over half of the students who attend public four-year institutions now borrowing from the federal government, and over 80% of students who attend private two- or four-year institutions now borrowing.²

Luckily for a lot of those borrowers, since 2006 new federal legislation has been working to overhaul the loan system with the intent to relieve debt. Among several changes, the interest rates for Stafford loans, the most popular of student loans, have been dropping--from the record-high 6.8% fixed rate (for fixed-rate loans made after July 1, 2006, and before June 30, 2008) to 6.0%, and now to 5.6%, and so on each year until the rate is halved at 3.4% in 2011–12. Too bad the rates are set to jump back up to 6.8% in 2013, unless Congress intervenes. Also too bad that graduate students are excluded from receiving the new lower rates.

One plus of the federal loan overhaul started this July 1. Now the amount you earn can determine the amount you have to pay back each month. The new option is called Income-Based Repayment (IBR). For those borrows who are eligible, most "IBR loan payments will be less than 10 percent of their income."³ Not bad. But the repayment plan doesn't reduce the principal you owe, and paying less each month means you're paying more in interest over time. For more information on IBR, try The Project on Student Debt.

Another change certainly looks impressive--it lowers interest rates to 1.88% or 2.48% (when the loan is in repayment mode) for borrowers who hold variable interest rates. But the change only affects students who hold variable rates, and on July 1, 2006, the government stopped issuing Stafford loans at variable rates of interest.

So if you used Stafford loans to borrow before July 1, 2006, you're in luck, and if you’re borrowing with them now, you’re also in luck. But if you’re a graduate student, or if you borrowed in the small twenty-four-month window during which the Stafford rate became fixed at 6.8%, well, you got the shaft.

If you fall into the shaft category, perhaps writing to Congress is your only hope. It wouldn’t hurt to try. In your letter, please feel free to pilfer anything you read in this post.

Resources for student loan relief:

The Project on Student Debt. Here you can also sign petitions to Congress for stronger debt-relief legislation and share your own experience with student loan debt.

The Institute for College Access & Success.

Student Loan Borrower Assistance, made available by the National Consumer Law Center. A wealth of information, including your legal rights as a borrower.



[1]The Project on Student Debt, "Quick Facts about Student Debt."

[2] Ibid.

[3] "Income-Based Repayment now Available," July 6, 2009, The Institute for College Access & Success, available at http://views.ticas.org.