by Christy Bieber | March 18, 2020
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While you're social distancing, here are some key financial lessons you can learn.
As the novel coronavirus threatens lives, Americans throughout the country are practicing social distancing to slow or stop the spread of the virus. This has left many people with time on their hands.
If you're looking for something to do to pass these difficult days while improving your long-term financial situation, now may be an ideal time to learn key concepts related to money management and growing your net worth.
Not sure where to start? Here are six concepts to learn about.
There are different kinds of budgets, including:
No matter what kind of budget you plan to make, you should:
You can learn more in our guide to how you can make a budget you're able to stick to.
If you're in debt, the debt snowball is a popular payoff method. The premise is that scoring quick wins helps you stay motivated to continue paying off debt. Here's how:
Let's look at an example. Say you're paying $100 a month to your credit card with the lowest balance, and $75 a month to the card with the next lowest balance. After you pay off the first card, you'd add that $100 to payments on the second debt, paying at least $175 every month on that debt. You'd continue until all your debts are gone.
There's another budgeting approach called the debt avalanche, which works similarly. Instead of starting with the lowest balance, you start with the debt with the highest interest rate and pay it off first -- even if the balance is bigger. It will take longer to score a win, but this approach is the most effective in terms of paying less in interest.
You can also check out our guide to nine ways to pay off debt to find out more.
Interest is the cost of borrowing, or the amount you're paid when you invest your money with a financial institution. It's expressed as a percentage of the loan amount or deposit amount. For example, you might be charged 6% interest on a loan, which means you pay 6% of the principal balance each year to borrow.
Lenders set interest rates based on your borrower profile if you're borrowing, always within a minimum and maximum. For example, a personal loan lender might advertise rates between 7% and 15%, with borrowers who have the best credit scores and sufficient income to repay the loan eligible for the lowest rate. When you borrow, lower interest rates are always better than higher rates, because a lower rate reduces the amount you have to pay back.
If you've borrowed at a high rate, you can sometimes refinance to pay off your debt. For example, it's common to take out a personal loan, which tends to have a lower rate, and use the loan proceeds to pay off high-interest credit card debt.
You can learn more in our guide to how credit card interest works.
You have lots of different credit scores, but most are on a scale of 300 to 850, with scores above 670 considered good, very good, or excellent, and scores below 670 considered fair or poor. The key factors that determine your score include the following:
Your net worth is how much your holdings are worth in total. It's calculated by:
A high net worth means you have assets that greatly exceed the value of your liabilities. A negative net worth happens when you have more debt than assets. Your net worth changes throughout your life as you repay debt and acquire property and investments. When your net worth is high enough, you're considered wealthy.
Mortgages are used to buy homes, since few people can pay cash for them. They are secured debt, which means there is an asset guaranteeing the loan that the lender can seize if you don't make your payments. The house is the asset that secures your mortgage.
Mortgages are typically paid off over a long time -- a 30-year mortgage is most common, although some people take out 15-year mortgages that come with higher monthly payments but cost less in total. If you itemize on your taxes, the interest you pay on your mortgage may be tax-deductible.
Qualifying for a mortgage often requires a lot of financial paperwork, including documentation of your income, and proof you don't have too much debt. You'll need at least a good credit score to get a loan from most lenders, although there are some loans with a government guarantee -- such as an FHA or VA loan -- that you can get with a score as low as 500 in some circumstances.
Lenders typically also want you to put a 20% down payment on the home to get a mortgage. If you're buying a $300,000 house, that would be a $60,000 down payment. This protects the lender if you can't pay your bills, because if the lender had to foreclose and sell the house, it should get back enough to repay the loan. While you can qualify for a loan with much less -- as low as 3.5% down in some cases -- this often means you have to pay for private mortgage insurance (PMI) to protect the lender from loss.
The impact of the novel coronavirus on your finances is likely to be profound for many people. While you may face challenges budgeting in the midst of a pandemic, you can use the time you're home to learn about these key financial concepts so you'll be better prepared for money management when life returns to normal.
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