Credits for dummies, theory

Credit, one of the main financial instruments, involves the borrowing of funds by an individual or legal entity from a lender with the obligation to repay the principal and interest within a certain period of time. Loans can be divided into several categories depending on their purpose, repayment periods, interest rates and collateral requirements.

Main types of loans

Personal loans (“for any purpose”) : Unsecured loans made to individuals based on their creditworthiness, often used to cover personal expenses such as medical bills, home renovations, or debt consolidation. These loans typically have a fixed interest rate and repayment terms of one to five years.
Mortgage Loans : Secured loans used to purchase real estate, where the property itself serves as collateral. Mortgages typically have longer repayment terms, typically 15 to 30 years, with a fixed or variable interest rate.
Auto loans : Secured loans intended for the purchase of vehicles. The car acts as collateral and these loans usually have a shorter repayment period, typically three to seven years, with a fixed interest rate.
Student loans : Loans designed to finance education expenses, often provided by governments or private lenders. They can have a fixed or variable interest rate and the repayment period can be up to 30 years, depending on the type of loan and the amount borrowed.
Business Loans : Loans provided to businesses for a variety of purposes, including working capital, expansion, or equipment purchases. They can be secured or unsecured and have a fixed or variable interest rate with varying repayment terms depending on the financial condition of the business and the purpose of the loan.
Demand Loans : Short-term, high-interest loans designed to cover immediate expenses until the borrower’s next paycheck. These loans often come with extremely high interest rates and fees, making them a less profitable and very risky option for borrowers.

Types of credit schemes

Revolving Credit : A line of credit that can be used multiple times up to a specified limit as long as the account remains open and active. Credit cards are the most common example of revolving credit.
Conventional Loan : A loan that is repaid with a fixed number of periodic payments, usually monthly. Mortgage loans, car loans, and consumer loans fall into this category.
Open-end loan : A type of loan that must be repaid in full every month, such as bank cards. Unlike a revolving loan, the balance cannot be carried forward to the next month.

Choosing the most profitable loan

When choosing a loan, the borrower must take into account several factors in order to choose the most profitable option:

Interest Rate : Interest charged on the principal amount of the loan. Lower interest rates lower the overall cost of borrowing. Fixed interest rates provide predictability of payments, while variable rates (as well as rates based on third-party currency exchange rates) can fluctuate over time.
Monthly payment : The amount paid each month consists of a payment that repays the “body of the loan” (i.e., towards the principal debt) and bank interest and commissions. It is affected by the loan amount, interest rate and repayment period.
Down Payment : A down payment made at the time of purchase that reduces the loan amount and potentially provides a lower interest rate.
Total Overpayment : The total amount paid over the life of the loan, including interest and fees. A lower overall overpayment indicates a more affordable loan. On loans with a long term, the overpayment usually exceeds the amount of the loan itself, but this includes not only the bank’s net profit, but also inflation.
Loan term : The duration over which the loan is repaid. Shorter terms tend to have higher monthly payments but lower total interest costs (overpayment), while longer terms tend to have lower monthly payments but higher total interest costs.

Calculations

Monthly payment

The payment is calculated taking into account the loan amount, interest rate and loan term. For fixed rate loans, the formula is as follows:

where “M” is the monthly payment, “P” is the principal amount of the loan, “r” is the monthly interest rate, and “n” is the total number of payments. Use an early repayment loan calculator to avoid making mistakes in your calculations.

An initial fee

A down payment reduces the principal amount owed on the loan, thereby lowering monthly payments and the total amount of interest paid. For example, a higher down payment on a mortgage may result in a better interest rate and more affordable monthly payments.

Total overpayment

The total overpayment is calculated by multiplying the monthly payment by the number of payments and adding any upfront fees or charges. Minimizing the total overpayment is the main thing that distinguishes an economically advantageous loan.

Interest rate

Interest rates can be fixed or variable. Fixed rates remain unchanged throughout the loan term, providing predictability. Variable rates fluctuate with market conditions, potentially offering lower initial rates but with the risk of higher rates in the future.

Early payments

Making early loan payments may reduce the total amount of interest paid. Borrowers can choose between reducing the monthly payment amount and shortening the loan term. Shortening the term usually allows you to save more on interest (reduce the overall overpayment), and reducing the monthly payment eases the payer’s credit burden and potential risks.

Annuity payments

The annuity payment system involves equal monthly payments throughout the loan term, combining the principal amount of debt and interest, with their combination changing over time - at first the payment contains mainly bank interest and only at the end of the term the loan body. This method is commonly used for mortgages, providing consistency in payments and making budgeting easier, but is unfair to the payer.

Rarer variants:

Balloon Loans : Loans with lower monthly payments and a large lump sum payment at the end of the term. Suitable for borrowers who expect significant income in the future or are planning to refinance the loan. Such a system is almost never found in Russia.
Interest-Only Loans : Loans in which only interest is paid during the initial period and repayment of the principal is deferred until the final period. They are usually characterized by a reduced interest rate, thanks to high guarantees for the bank to receive a full profit. May be useful for borrowers expecting higher future income or investment returns.
Adjustable Rate Mortgages : Mortgages whose interest rates change periodically based on a prime rate. They typically start with lower rates than fixed-rate mortgages but carry the risk of higher loan costs.
Peer-to-Peer Loans : Loans financed by individual investors through online platforms. These loans may offer competitive rates and flexible terms, but borrowers should evaluate the platform’s reliability and fees.