Borrowing money is the act of receiving money from a lender who you agree to repay on a payment schedule set by the lender. That simple relationship comes in many forms, can have an extensive library of unique terms, and could be subject to changing government regulations all of which are too extensive and complex to cover in this book.
Without getting too deep in the details, this chapter will look at:
For consumers in the United States, there is the Consumer Financial Protection Bureau. Founded in July 2011, the CFPB was created to provide a single point of accountability for enforcing federal consumer financial laws and protecting consumers in the financial marketplace. This government agency is tasked with making sure that banks, lenders, and other financial companies treat you fairly.
The CFPB website (consumerfinance.gov) is your one best resource for learning about the financial marketplace. As highlighted on the screenshot at left (captured on 2/19/2022), the CFPB is also where to turn for help when you have a complaint about a financial transaction in which you feel that you were treated poorly or lost money.
You are encouraged to bookmark the CFPB website in your browser as a financial resource, which is equivalent to having your therapist on speed dial for emotional issues. Look to the CFPB website as your go-to place for topics that could include:
An advantage of having the CFPB website as your financial marketplace reference is that the website is kept up to date with current financial and government activities. You would do well to visit the site often when engaging in money discussions and transactions.
Personal debt generally falls into three categories or levels: long-term, short-term, and convenience.
Long term debt typically means a 30-year mortgage used to purchase a primary residence. For most people, a mortgage is the largest debt they will ever take on. There are other loans that fit in the long-term category, such as education loans, because the loans take so long to pay off.
Long-term debt can be advantageous for building a good credit rating and, for mortgages, to take advantage of tax advantages and to build equity (the cash value of your home that is yours). In the case of student loans, the debt is offset by the increased income that can be earned with an advanced education.
Short-term debt, which typically lasts three to seven years, is used to purchase big ticket items such as:
These are the items that get us mobile, make our house a home, and are just plain fun.
Convenience debt refers to using credit cards, which provide a convenient way to make purchases, particularly online. Credit cards are not always considered convenience debt. They can easily be short-term and possibly long-term debt. The difference is whether or not you pay interest to the credit card company. When you don’t pay a statement’s new balance every month, the credit card is at least short-term debt. If you continue to use a credit card and never bring the account balance down to zero, the credit card is a long (as in perpetual) debt.
A credit card is a convenience only when you pay the statement’s new balance in full each month. Otherwise, the credit card is a very expensive debt.
Your creditworthiness for borrowing money is measured a great deal by lenders with your credit score and your debt-to-income ratio (DTI). There are other metrics that may come into play depending on the type of loan for which you're applying, but your credit score and DTI are important creditworthiness numbers that you can monitor and change with appropriate handling of your day-to-day finances.
Credit Report vs. Credit Score
This text was copied from a CFPB post titled, “What is the difference between a credit report and a credit score?” which was last updated on August 3, 2017:
Your credit reports and your credit scores are two different things. A credit report is a statement that has information about your credit activity and current credit situation such as loan paying history and the status of your credit accounts. Your credit scores are calculated based on the information in your credit report.
Your credit score, as well as the information on your credit report, are important for determining whether you’ll be able to get a mortgage, credit card, auto loan, or other credit product, and the rate you’ll pay. Your credit scores are calculated based on the information in your credit report.
You have many different credit scores, and there are many ways to get a credit score. Your score can differ depending on which credit reporting agency provided the information, the scoring model, the type of loan product, and even the day when it was calculated. Higher scores reflect a better loan paying history and make you eligible for lower interest rates.
Errors on your credit report can reduce your score artificially - which could mean a higher interest rate and less money in your pocket - so it is important to check your credit report and correct any errors well before you apply for a loan.
Refer to the CFPB website for ways to get your credit report and credit score.
How To Improve Your Credit Score
This text was copied from a CFPB post titled, “How do I get and keep a good credit score?” which was last updated on March 29, 2019:
There is no secret formula to building a strong credit score, but there are some guidelines that can help.
If you need help improving your credit score, a credit repair company will negotiate with your creditors and credit agencies on your behalf in exchange for a monthly fee.
When you have a great credit score, it could be worthwhile to utilize a credit monitoring service to keep your information secure.
Your debt-to-income ratio (DTI) is all of your monthly debt payments divided by your gross monthly income expressed as a percent. It indicates to lenders your ability to handle the monthly payments for the money you want to borrow.
While debt-to-income ratio standards used by vendors vary, a typical interpretation of your DTI by a lender could be:
When applying for a credit account for which your debt-to-income ratio is considered, ask the lender for the specific levels being applied.
How To Calculate Your DTI
Step 1 - Add up your monthly bills.
Step 2 - Add up your gross monthly income.
Step 3 - Divide your total monthly bills by your total gross monthly income. Multiply the result by 100 to get your debt-to-income ratio in percentage.
You can use the Debt-to-Income Ratio Calculator in Income Companion as shown below.
When a lender asks for the information needed to calculate your DTI you could:
The one question about borrowing money that websites and creditworthiness metrics cannot answer is how well the payments fit into your Incredibly Cool Budget, or, Can you afford it? This is when playing “What If?” becomes a critical part of your financial planning. Being able to actually see the impact of a new commitment on your financial future both clarifies the choices and helps you to be comfortable with your final decision. With a few steps, you can see how a new loan or any other type of payment will affect your bottom line.
First, shop for the best deal. Look on the CFPB website for how to prepare for and negotiate the type of loan you are looking at. Go shopping for a loan armed with full knowledge of the relevant key terms, vendor disclosure requirements, and your rights. Once you have a tentative, unsigned loan agreement with the payment amount and schedule, you can use Income Companion and:
If you are okay with the changes to your bottom line and debt-to-income ratio in the cloned budget space that are a result of the tentative payments, you can proceed confidently with the loan. After the loan has been completed, add a bill to the live budget space to include the payment schedule in your Incredibly Cool Budget.
If the tentative payments added in Steps 5 and 7 above result in unacceptable, negative changes to your cash flow or debt-to-income ratio, what you do next is up to you given your financial situation. You could look at:
By playing “What If?” with the contemplated loan payments, you will know whether or not they are a good fit in your Incredibly Cool Budget, and, if not, you will be able to consider all of your options.