Loans and credit (article) | Borrowing money | Khan Academy (2024)

Have you ever wanted to buy something that you couldn't afford with the money you have right now? Maybe you need a new laptop for school, a bike to get around, or a trip to visit your relatives. Or maybe you have an unexpected expense, like a car repair, a medical bill, or a home improvement. How can you pay for these things without waiting for months or years to save up the money?

One option is to borrow money from someone else, such as a family member, a friend, or a financial institution. This is called taking out a loan or using credit. When you borrow money, you agree to pay it back later, usually with some extra money added on top. This extra money is called interest and fees, and it is the cost of using someone else's money.

People use credit for different reasons, depending on what they need and want. Below are just some of the reasons someone might use a line of credit.

A car can cost a lot of money, but it can also help you get around. Many people get a car loan from a bank, a credit union, or a car seller to pay for a car over time, instead of paying all the money at once.

A house can cost even more money, but it can also be a good investment and provides you with a place to live. Most people get a mortgage from a bank, a credit union, or a mortgage company to pay for a house over time, instead of paying all the money at once.

School can help you learn new things and get ready for a job. But it can also be very expensive, especially for college or university. Many people get student loans from the government or private lenders to pay for school or training, books, and living costs while they study.

Sometimes, bad things happen that we can't control or avoid, like a storm, a sickness, a legal problem, or a family problem. These things can make us spend money that we don't have. In these cases, some people use credit cards, personal loans, or payday loans to get some fast money to deal with the problem.

Interest is the amount of money that you pay to the lender for using their money. It is usually expressed as a percentage of the amount you borrow, and it is charged over a period of time, such as a month, a year, or the entire term of the loan.

Not all loans and credit have the same interest rate. Some places charge more or less interest than others, depending on many things, like your credit score, your income, your property, and the kind and reason of the loan.

On the other hand, a credit card may have a higher interest rate than a mortgage, because a credit card is not backed by anything. This makes it riskier for the bank, and because a credit card can be used for anything, it may make you spend more or miss payments.

Interest is important because it changes the total price of borrowing money over time. The higher the interest rate, the more money you have to pay back to the place that lends you money, and the longer it may take you to pay off the loan. The lower the interest rate, the less money you have to pay back to the place that lends you money, and the faster you may be able to pay off the loan.

For example, if you borrow $\mathrm{\$}\mathrm{1,000}$‍ from a bank at $10\mathrm{\%}$‍ interest per year and pay it back in one year, you will pay a total of $\mathrm{\$}\mathrm{1,100}$‍, which is $\mathrm{\$}100$‍ in interest. If you borrow the same amount from a credit card at $20\mathrm{\%}$‍ interest per year and pay it back in one year, you will pay a total of $\mathrm{\$}\mathrm{1,200}$‍, which is $\mathrm{\$}200$‍ in interest. If you borrow the same amount from a payday loan at $400\mathrm{\%}$‍ interest per year and pay it back in one year, you will pay a total of $\mathrm{\$}\mathrm{5,000}$‍, which is $\mathrm{\$}\mathrm{4,000}$‍ in interest.

As you can see, the interest rate makes a big difference in how much you end up paying for borrowing money. So, it is important to compare the interest rates of different places that lend money before you choose one.

There are many places that lend money to people, depending on what they need and want. Here are some of the places that lend money.

Banks are places that offer many kinds of loans and credit, like mortgages, car loans, personal loans, credit cards, and overdrafts. Banks usually have hard rules, like needing a good credit score, a steady income, and a down payment or property. Banks usually charge medium interest rates, depending on the kind and time of the loan. Banks usually have set payment plans, like monthly payments, and may charge fees for late payments, early payments, or other services. Banks usually have offices, machines, and websites that make it easy and helpful to borrow money from them.

Merchants are places that sell things or services, like stores, car sellers, or schools. Merchants lend money to their customers, either by themselves or through a bank or a finance company. They usually have easier rules, like needing a proof of who you are, how much you make, or a down payment. Typically they charge high interest rates, especially if they offer no-interest or low-interest deals that end after a while. Merchants may have flexible payment plans, like monthly payments, delayed payments, or minimum payments. They have limited locations, hours, and options that affect how easy and helpful it is to borrow money from them.

Peer-to-peer is a way of lending and borrowing money that involves people or groups, not places. Peer-to-peer may use online platforms, like websites or apps, that connect lenders and borrowers, and charge a fee for doing that. Peer-to-peer may have different rules, depending on what the lender wants and what the borrower has, like their credit score, their income, their reason, and their friends.

Peer-to-peer may charge low to high interest rates, depending on how many people want to lend or borrow money, and how risky and rewarding the loan is. Peer-to-peer may have flexible payment plans, like monthly payments, one-time payments, or donations. Peer-to-peer may have good and bad things in terms of how easy and helpful it is to borrow money from them, depending on how good and reliable the platform and the people are.

Payday loans are short and expensive loans that are meant to give cash until the next payday. Payday loans are usually offered by special places, like shops, online platforms, or check cashers. Payday loans usually have very easy rules, like needing a proof of who you are, how much you make, and a bank account.

Payday loans usually charge very high interest rates, often as fees that are based on how much and how long you borrow money. Payday loans usually have very short payment plans, like two weeks or one month, and may need you to give the place access to your bank account or a check for later. Payday loans usually have limited ease and help, and may make you face problems like getting stuck in debt, getting harassed, or getting your identity stolen.

Title loans are short and expensive loans that are backed by the title of a vehicle, like a car, a truck, or a motorcycle. Title loans are usually offered by special places, like shops, online platforms, or pawn shops. Title loans usually have easy rules, like needing a proof of who you are, how much you make, and a clear title of the vehicle.

Title loans usually charge very high interest rates, often as fees that are based on how much and how long you borrow money. Title loans usually have very short payment plans, like two weeks or one month, and may need you to give the place the vehicle or a set of keys. Title loans usually have limited ease and help, and may make you face problems like losing the vehicle, paying more than the value, or hurting your credit score.

The table below shows the main things and costs of different places that lend money:

There is no one answer to this question, as different places may work better for different people and situations. But some tips to help you make a smart and careful decision are:

• Know what you need and want: Why do you need to borrow money? How much do you need? How long do you need it for? How will you use it? How will you pay it back? These are some of the questions you should ask yourself before you get a loan or credit. This will help you choose the most fitting and cheap place for your reason.
• Know how much you have and can afford: How much money do you make? How much money do you spend? How much money do you save? How much money do you owe? These are some of the questions you should ask yourself before you take a loan or credit. This will help you know how much you can borrow and repay, without hurting your money health and happiness. You should always borrow what you can afford and avoid getting more debt than you can handle.
• Know your choices and other ways: What are the different places that lend money to you? What are their good and bad things? How do they compare in terms of interest rates, fees, payment plans, ease, and help? These are some of the questions you should ask yourself before you choose a loan or credit. This will help you see the benefits and drawbacks of each place, and find the best deal and value for your money. You should also think about other ways to pay for your needs and wants, like saving, earning, or selling, before you borrow.

Loans and credit are ways of using money that is not yours. You have to pay it back later, and you also have to pay some extra money. People use credit for different reasons, like buying a car, a house, school, or emergencies.

Interest is the money that you pay to the place that lends you money, and it changes the price of borrowing money over time. The places that lend money are banks, merchants, peer-to-peer, payday loans, and title loans, and they have different rules, interest rates, payment plans, fees, and problems.

To choose the best place to lend money, you should know what you need and want, how much you have and can afford, and your choices. You should also use credit smartly and carefully, and avoid getting into debt trouble.