Let's start off with the basics. A loan is an amount of money that is given from a lender to a borrower with the expectation of repayment in the future. Think of it at its simplest form: if you've ever borrowed $5 from your friend for some ice cream and said "I'll pay you back," you have essentially borrowed a loan from your friend, who is in this situation, the lender. Loans can, however, be much more serious than owing your friend money for ice cream. Loans are indeed a type of debt, so if you are not responsible with making payments, then you can end up with unmanageable debt. Loans fall into one of two categories: secured and unsecured.
These loans are secured by one of your assets, such as your home, which is used as a collateral. If you default on your loan, your lender will get the money back by seizing your collateral, which, in the case of your home, means foreclosure. The interest rate on these loans is low and often negotiable depending on your credit score. Types of secured loans include car loans, boat loans, mortgages, home equity loans, and home equity lines of credit.
As opposed to secured loans, unsecured loans are not secured by an asset. If you default on an unsecured loan, the bank can only utilize collectors and freeze your account. Your credit history plays a large role in the loan amount that you granted, since the lender takes more of a risk. The interest rate on unsecured loans is also higher than secured loans. Types of unsecured loans include personal loans, personal lines of credit, student loans, and credit cards.
The Different Types of Loans
If you are considering taking out a loan, it is important to learn about the many options that you have available for you. Whether you are looking to take out a car loan or student loan, you have more than one option. Belowe is a quick guide to the four types of loans − lines of credit, conventional loans, mortgages and credit cards.
Lines of Credit
A line of credit works in a similar way as a credit card. You are given a maximum balance, and each month you are allowed to borrow as much as you want from the credit, as long as it is below the maximum amount. Your monthly minimum payments can either be a percentage of your balance or a very low fixed amount. Lines of credit can come with checks, or can be linked to your bank account. These can be either secured or unsecured.
These loans include home equity loans, personal loans, car loans, and so on. Your repayment term and amortization will be determined when you take out the loan; the lender will offer you a fixed interest rate and amount of time that the loan must be paid in. Since there is usually a short amount of time to pay it back, the monthly payments for conventional loans are usually fairly high. Similar to lines of credit, conventional loans can be secured or unsecured.
Mortgages are probably the most complicated type of loan due to the largeness of their amounts. Like mentioned earlier, mortgages are secured loans that use real estate as their collateral. Repayment can range from 25 to 30 years, depending on the amount of the loan. The amount of interest you will need to pay varies depending on your credit, and can either be fixed or variable. Since there is so much interest involved in mortgages, it is almost always paid up front. Therefore, the first few years of paying your mortgage will consist entirely in paying off the interest. To learn more about mortgages, check out our guide to applying for a mortgage.
You've probably heard the phrase "save your money, pay with cash." There is no denying that credit cards oftentimes get a bad rap. However, used correctly, credit cards can be very useful. Not to mention, they are nearly necessary in today's society. When you get a credit card, you will be given a maximum balance, and can spend as much as you want with it as long as it is under the maximum. Most credit cards are unsecured, and have interest rates that range from 10% to 20%. The good thing about credit cards is if you pay back the full balance by your due date, you will not be charged any interest. The key thing to keep in mind about credit cards is to never spend more than you make.