Chapter 15- Borrowing for Households and Individuals Flashcards
What does borrowing mean?
Borrowing means receiving money from a person or financial institution, in exchange for a promise to pay back the money (with interest) at an agreed time in the future
What is interest
Interest is the additional cost on top of the money you borrow that you must pay if you are borrowing money from a financial institution. It is the financial institution’s reward for lending you the money (2 meanings)
What factors should you consider before borrowing? (4)
- Do I really need the item/money?
- Can I get the money another way, without having to borrow?
- How much will it cost? (think about the interest you must pay)
- Can I afford the repayments?
Define instalment
A fixed sum of money due on the same date for a specified period of time until the loan and interest is repaid
Define asset
Anything owned by an individual, household or business that is worth money EG a house, car, machinery
Define creditworthiness
An estimate of someone’s ability to pay off a loan based on their saving and borrowing history
Define guarantor
A person who has a good credit rating who agrees to pay your loan for you if you are unable to do so
Define collateral
Something, usually an asset, used for security for repayment of a loan (EG the deeds to a house). If you cannot repay the loan, the financial institution can take the asset to pay the loan
Define insolvent
When a person is unable to pay their debts off when they need to
Define responsible borrowing
Not borrowing more than you are able to pay back
Reasons for borrowing? (5)
- To pay for expensive item EG house
- To deal with short term deficit (unable to pay bills on time)
- For emergencies EG operation
- For unplanned expenditure EG house repairs
- To pay for college fees
What are the 3 types of borrowing?
Short-term (1yr), medium-term (1-5yrs), long-term (5+ yrs)
Short-term sources of finance (bank overdraft)
Definition: A person is given permission to withdraw more money from their bank account than is in it
Reason to Use: To pay a household (EG electricity) bill
Short-term sources of finance (credit card)
Definition: A credit card holder can buy items now and pay for them at a later date (usually 30 days later)
Reason for Use: To buy a present for a birthday
Medium-term sources of finance (medium-term loan)
Definition: A loan that is paid back, with interest, between 2-5 years
Reason for Use: New kitchen fitted
Medium-term sources of finance (hire purchase)
Definition: A person pays monthly instalments to a hire purchase company for a fixed period of time. They do not own the item until the last instalment is made.
Reason for Use: To buy a car
Medium-term sources of finance (leasing)
Definition: A person rents an asset from a leasing company. They pay to use the asset for a set period of time but they never own the asset
Reason for Use: To use a piece of machinery for repair (digger)
Long-term sources of finance (mortgage)
Definition: A mortgage is a special type of long-term loan that is taken out to buy a property. These can be paid off between 15-35 years
Reason for Use: To buy a house
What information is needed when applying for a loan?
- Personal details (name, DOB)
- Employment details
- Savings record
- Borrowing history
- Purpose for loan
Define APR
Annual Percentage Rate:
A calculation of the overall cost of a loan and represents the actual yearly cost of the amount borrowed
Define declining principal
The amount you still owe at any point during the loan. It is going down each month because of the repayments
Define cost of credit
The difference between the amount you borrow and the total you repay
How to calculate APR
Calculate the interest, add it to the original amount, and then take the original amount from this figure to get the cost of credit. Don’t forget about the declining principal
