Ultimate Loan Tools (Part 2)
You know, it's not all about the money we owe. Sometimes, it's about the money we borrow. While debt is often seen as a burden, loans can be viewed as a tool. Be it for buying a house, funding education, or starting a business. Loans are often the financial bridge that helps us reach our goals.
Download our Ultimate Loan Tools (Part 2) now, available in Google Sheets, and Microsoft Excel to oversee loans, analyze optimal repayment methods, and maintain financial stability to avoid a debt snowball.
Let's start with a real-life example that illustrates the potential benefits of intelligent loan usage. Mark Zuckerberg, the founder of Facebook, took a $100,000 loan from his father to kickstart what would become a global social media phenomenon. This initial investment was instrumental in transforming Facebook from a college project into the global social media powerhouse it is today. Today, Facebook is worth hundreds of billions of dollars, making that initial loan one of the most successful investments in history.
Contrasting with the success story of Mark Zuckerberg's strategic loan use is the unfortunate case of Hertz Global Holdings. The car rental company, burdened with $24.35 billion in liabilities, filed for bankruptcy in May 2020. Hertz's attempts to expand into the consumer travel market, funded by substantial loans, did not yield the expected returns. As the company's market share declined, the weight of the debt became insurmountable. This is a stark reminder of the potential risks of loans and the importance of strategic decision-making.
First off, what do you need to know about loans? Some concepts can significantly impact the overall cost of the loan and your ability to repay it. To illustrate this, let's use the case of Hertz Global Holdings along with our Ultimate Loan Tools (Part 2):
In the early 2000s, Hertz flourished and decided to expand aggressively into the consumer travel market. To do so, they obtained a substantial loan for this ambitious venture. Before diving into the more common aspects, let's explore the concepts of an interest-only period and balloon payments, which can mean the difference between a loan that's a stepping stone to success and becomes a financial burden.
To opt for an interest-only period, in Heartz's case, would mean that they were only responsible for paying off the interest part of the loan initially. This can make the loan seem more affordable at first. Still, it means that the principal, the amount Heartz borrowed, isn't decreasing during this time.
Compare loan details: interest-only period
In our template, you can observe the impact of having an interest-only period by comparing two amortization charts side by side. First, let's enter the crucial loan parameters - the principal amount, the interest rate and the repayment term. This will generate a standard amortization chart that represents the lifecycle of a typical loan. Now, let's introduce an interest-only period to the second chart.
Notice how we don't have a column for the interest amount at the beginning of the interest-only period amortization chart. So, what's the consequence of this? After the interest-only period, you'll have to make higher monthly payments toward the principal amount for the remainder of the repayment term. Understanding this dynamic is crucial in assessing whether an interest-only loan fits your financial situation.
Compare loan details: balloon payments
Another possibility is the balloon payment. A balloon payment is a large, lump-sum payment you make at the end of the loan term. It's like saving the most significant piece of your financial pie for the last bite. This means that while Heart'z regular monthly payments are relatively low, they will have to make a large payment at the end of the loan term. This can be a surprise if you need more preparation for it.
We can enter a balloon payment in our template and analyze how this would look in the repayment term. As a result, we can notice how the principal amount paid over time has decreased, but by the end of it… boom! Here is the balloon payment, clearly standing out in our amortization chart. This payment is so much larger than the others, so it can be hard to pay it down and be one of the reasons why the loan has become an unpayable debt - like in Heartz's case.
However, loan terms can offer more flexibility than this. We've been operating under the assumption of a constant interest rate throughout the loan lifecycle. But what if that's not the case? Let's talk about variable and fixed interest rates.
A fixed interest rate provides a sense of stability. It remains constant for the duration of the loan, ensuring your payment amounts are predictable. This consistency simplifies budgeting, as your repayments will remain steady over time.
On the other hand, a variable interest rate is tied to an index influenced by market forces, resulting in fluctuation throughout the loan's term. This changeability means your repayments could increase or decrease, offering potential savings if the rate falls but also carrying a risk if the rate rises.
Extra payments and other repayment strategies
What if I told you that the loan repayment scenario could still be improved? Suppose Hertz can make additional payments to their loan beyond the stipulated monthly repayments. These are called 'extra payments'. By making extra payments, Hertz can reduce their principal amount faster, thus paying less interest over the life of the loan.and repay it sooner than initially planned. It's a strategic move that can save a lot of money and this can also be noticed by adding some extra payments to the repayment schedule we have so far.
Now, we can better explore how making extra payments can influence the course of the loan. We should ask ourselves two key questions
- How much can I reduce my loan cost with regular extra payments?
- How much in regular extra payments do I need to pay off my loan within a specific timeframe?
The template offers answers to these questions. We can select the Hertz loan we just created and provide the following:
- Additional details like the date when the extra payments started.
- The total number of extra payments made.
- The frequency of these payments.
The tool then calculates how much you've managed to reduce your loan cost – the results can be pretty surprising! This way, you can analyze how to optimize the cost of your loan to the maximum and put this into practice as shown before. The template then serves as a complete tool to help you not just in analyzing your loan options but also in tracking, monitoring, and optimizing your loan
Ultimately, the key to successfully navigating the world of loans and debts is understanding and managing these financial tools effectively. It's about making informed decisions, staying disciplined, and monitoring your financial health. After all, as Benjamin Franklin once said, "An investment in knowledge pays the best interest."