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BORROWING

Borrowing Basics

Get a clearer picture of your options. Explore helpful articles covering borrowing, repayment, and more.
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Borrowing can be a helpful way of spreading the cost of a purchase, covering an unexpected expense, or accessing money before you have saved the full amount. 

Before borrowing, it is important to understand how it works, what it will cost, and the terms you are agreeing to.

How does borrowing money work?

Borrowing is when a lender or credit provider gives you money, or access to credit, that you agree to repay. In most cases, you will also pay interest or fees for using the money.

The process starts with an application. The lender may ask about your income, expenses, existing debts, and credit history before deciding whether to approve your request and what terms to offer.

Once approved, you can receive the money as a lump sum or get access to a credit limit, depending on the type of borrowing. 

A lump sum is usually repaid through regular installments. A credit limit allows you to borrow, repay, and borrow again, provided you stay within the agreed limit.

The lender should provide a borrowing agreement, which will outline things like:

  • How much you can borrow
  • The interest rate and APR
  • Any fees that apply
  • How much and how often you need to pay
  • How long repayment will take
  • What may happen if you miss a payment

The exact process and terms will depend on the lender and the type of borrowing.

Common borrowing terms

Here is a breakdown of some of the most common borrowing terms you might come across. Understanding what they mean can make it easier to compare your options.

  • Principal: The original amount you borrow, before interest and fees are added.
  • Interest rate: The percentage used to calculate how much interest you may pay.
  • Annual Percentage Rate (APR): A yearly measure of the cost of borrowing that includes the interest rate and certain fees.
  • Repayment term: The length of time you have to repay what you borrow.
  • Installment: A scheduled payment made toward the amount you owe, typically monthly.
  • Fees: Additional charges that may apply, such as origination, late payment, or returned payment fees.
  • Collateral: An asset used to secure borrowing, such as a car or home.
  • Default: Failing to repay according to the terms of the borrowing agreement.

The exact meaning and application of these terms may vary between products, so it is important to read the lender’s agreement carefully.

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Woman filling out an online loan application from home.

Interest rates and APR

The interest rate shows the percentage a lender charges for borrowing money. It affects how much interest is added to the amount you owe, but it may not include every cost connected with the borrowing.

APR provides a broader way to compare costs. It combines the interest rate with fees and expresses the result as a yearly percentage.

For example, one borrowing option may have a lower interest rate but higher fees. Another may have a slightly higher interest rate with fewer fees. Comparing the APR can help show which option may be more expensive overall.

APR is useful for comparison, but it does not always show the exact amount you will repay. The total cost will also depend on how much you borrow, the repayment term, the payment schedule, and whether additional charges apply.

Secured vs unsecured borrowing

Borrowing can be secured or unsecured, depending on whether an asset is used to support the agreement.

  • Secured borrowing: This is backed by collateral, such as a car, home, or savings account. If you do not keep up with repayments, the lender may be able to take the asset.
  • Unsecured borrowing: This does not require collateral. Instead, the lender looks more closely at factors such as your credit history, income, and existing debts.

Because secured borrowing may reduce the lender’s risk, it may offer lower rates or higher borrowing limits than comparable unsecured products. However, the risk may be greater as the asset could be lost, if payments are missed.

Unsecured borrowing does not put a specific asset at risk, but approval may be more difficult, and the cost may be higher, especially if the lender considers your application more risky.

Installment vs revolving borrowing

Borrowing can also be grouped by how the money is accessed and repaid.

  • Installment borrowing: You receive a fixed amount and repay it through scheduled payments over the agreed term. Each payment usually includes part of the amount borrowed and part of the interest.
  • Revolving borrowing: You receive access to a credit limit and can borrow up to that limit when you need to. As you repay the balance, the available credit may become accessible again.

Installment borrowing usually has a clear repayment schedule and end date. This can make it easier to understand how much you need to pay and when the balance should be cleared.

Revolving borrowing is more flexible, but the amount owed and the payments can change. Carrying an outstanding balance for a long time may also increase the total interest you pay.

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What is creditworthiness?

Creditworthiness is a lender’s assessment of how likely you are to repay what you have borrowed. It can affect whether your application is approved, how much you can borrow, and the terms you are offered.

Lenders may consider several factors, including:

  • Credit history: Your record of managing loans, credit cards, and other accounts.
  • Credit score: A number based on information in your credit report that helps lenders assess risk.
  • Income: The money coming into your bank account and whether it will be enough to support repayments.
  • Existing debt: The amount you already owe and the payments you are responsible for.
  • Payment history: Whether you have made previous payments on time.
  • Collateral: The value of any asset offered to secure the borrowing.

Each lender may assess these factors differently. Having strong creditworthiness does not guarantee approval, but it may improve your chances of receiving more favorable borrowing terms.

What are repayment terms?

The repayment terms explain how and when borrowed money must be paid back. They are part of the borrowing agreement and can affect the size of each payment and the total amount you repay.

Repayment terms can include:

  • Repayment period: The length of time you have to repay the balance.
  • Payment amount: How much you are expected to pay for each installment.
  • Payment frequency: How often payments are due, such as weekly, biweekly, or monthly.
  • Fixed or variable rate: Whether the interest rate stays the same or may change over time.
  • Due dates: The dates by which payments must be made.
  • Early repayment terms: Whether you can repay the balance early and whether any charges apply.
  • Late payment terms: The fees or other penalties that may apply if a payment is missed.

A longer repayment term could reduce the size of each payment, but it can also increase the total interest paid. A shorter term may cost less overall, but the regular payments are likely to be higher.

Woman applying online for a personal loan.

What should you check before borrowing?

Before borrowing, check:

  • How much you need to borrow
  • The APR, interest, and fees
  • The payment amount and frequency
  • The length of the repayment term
  • The total amount you may repay
  • Whether collateral is required
  • What may happen if you miss a payment

Read the agreement carefully before accepting the terms. It is also important to consider whether you really need to borrow or whether another option may be available.