Like it or not, most of us have or will take a loan sometime in the future. Although, maybe you don’t want to have a loan, the fact is that some times, during a specific period of your life, or a period of financial distress, you will need a loan. That is unless you belong to rich and wealthy category of people. So, in order for you to be better safe than sorry, you should primarily inform yourself about the different types of loans that could be found out there. Try understanding the basic features of the different types of loans. Meaning, that you should grasp the logic of the characteristics behind the general loan categorization and specific loans.
Again, before applying for a loan, you should sit down and consider the different possibilities you have at your disposal. Namely, you should make sure that you know the different types of loans. Understanding the loans will help you make a better and informed decision regarding a loan that will be suitable for your needs, which is second key issue to remember. Meaning that, you should know what the reason you are taking a loan is. Thus, it would be much easier for you to select the best loan when shopping around.
The need for gathering information is to ensure that you will have the best loan with the best terms in accordance to your life style and financial situation. Always remember that some loans are more expensive than others.
Prior to the explanation of the types of loans, you should be able to define what is loan. A loan is the process in which one entity is giving money or other form of asset to another entity. The money or assets, are given with the expectations for future repayment of the principal amount, plus an interest or other form of changes. Thus, do not expect that you will get a free money, you must pay back your loan plus the interest you are charged with.
Types of loans according to their basic features
If you are not aware that there are numerous types of loans, then you might get confused. Consequently, it could be said that loans can be categorized in accordance to couple of factors, basically representing crucial characteristics of the loan. Thus, the different types of loans could be categorized in terms of the following factors:
- The need for collateral
- Unsecured loans
- Secured loans
- Repayment terms and terms for reusing of funds
- Open-end credit
- Close-end credit
- Time to maturity
- Short-term debt
- Intermediate-term debt
- Long-term debt
- Loan purpose
- Loan approved for a specific purpose
- Buying a home (mortgage loan)
- Buying a car – car loan
- Buying in store – Consumer loan
- Loans for general use (no specific purpose)
- Personal loan
- Credit card
- Loans according to their interest rate
- Variable rate loans
- Fixed rate loans
- Loan approved for a specific purpose
On the basis of the whether a loan needs a collateral or not, we can distinguish two basic types of loans, secured and unsecured loans.
Secured loans (collateral loans) – a loans that are tied up against some form of asset. This way the lender is ensuring that the loan would be paid back, in case you fail to meet your monthly obligations. The underlying asset is referred to as a collateral or guarantee. This implies that, in case of a loan default, the lender has the right to repossess the asset and cover the loan. Due to the fact that the lender is protected against non-repayment of loan, interest rates on secured loans tend to be lower compared to interest rates on unsecured loans.
Unsecured loans – unlike secured loans, with unsecured loans you do not need to provide asset as a collateral. These loans are approved on the basis of your credit score and credit history, as well as the level of your income. Because these loans, are not guaranteed with an assets, they usually have higher interest rates. They are perceived by the lenders as riskier types of loans.
Taking into consideration the loan repayment terms, a difference among various types of loans can be found. This is taking into consideration the possibility to reuse the repaid amount. Meaning that, some types of loans have a revolving characteristics, while, other loans, do not offer this possibility. In line with the aforementioned, the loans can be placed in two categories, open-end credit and close-end credit.
- Open-end credit – this type of consumer credit is also referred to as a revolving credit, because of the way it can be used. The revolving credit, can be used continuously for purchases. The outstanding amount is repaid back on a monthly basis, either in full or portion of the outstanding debt. An example for a well know product that falls in the category of open-end credit are the credit cards. In addition, home equity lines of credit (HELOC) belong to this category. These loans have a so-called credit limit, representing the maximum amount you could borrow at once. You are not obliged to use the entire limit at once, you can use the available funds, as you need.
- Closed-end credit – is most often used as a means of financing a specific intent during a specific period of time. The closed-end credit is also referred to as an installment loans because of its repayment obligation. Namely, consumers have a pre-defined payment schedule and are obliged to make a regular payment. The most common payment schedule is the monthly schedule. Consumers are charged an interest rate until the full repayment of the principal amount. The interest rate charged can be different among lenders as well as borrowers, because of the importance of borrowers credit score. Some examples of a closed-end credit are: mortgage, car loans, appliance loans, etc.
Loans can be classified from the “time” point of view. In other words, not all loans have the same maturity date. Meaning that, they differ in terms of their repayment period. Hence, in accordance to the repayment period, there are three basic categories: mid-term loan, intermediate-term loan, and long-term loan. The short-term loan is a loan that should be repaid in one year or less. The intermediate-term loan is commonly characterized with a repayment period of anywhere from one year to five years. The long-term loans are considered to be loans with maturity period of more than five years, but most often they have a repayment period of ten years and more.
Another categorization of the loans can be performed with reference to the purpose of the loan. Namely, if you want to renovate your house, or purchase some appliance, you could find a loan designed specifically for these purposes. On the other hand, you could apply for a loan without having any specific purpose in mind (yes this is hardly the case, since you always know why you take the loan). For instance, you could take a loan (no specific purpose loan) to pay for some unexpected expenses.
Furthermore, loans can be classified on the basis of the type of interest rate they have. Namely, a loan could be assigned with a variable interest rate or a fixed interest rate.
- A variable interest rate loan is considered to be a loan where the interest rate applicable to the outstanding balance can change in accordance to the variations in market interest rates. Meaning, that the interest rate is adjusting to the market interest rate. Thus you could end up paying much higher or much lower interest rate on your loan, regardless of the interest rate at the time of signing the agreement.
- On contrary, fixed interest rate loan, is characterized as a loan in which the interest rate remains the same through the life of the loan. Meaning that, regardless of the movements in the market interest rates, you are paying fixed interest rate on your loan. With other words, you will pay the interest rate that has been agreed upon at the time of signing the loan agreement.
The aforementioned types of loans are based on the classification taking into consideration the general loans features. Aside of this classification, there is one more classification i.e. the types of loans as they are offered by the banks and other financial institutions. For that reason, there is a need for some of these loans to be listed and briefly explained. Accordingly, the different types of loans are briefly explained in the subsequent lines.
- Student loans – are loans available to college students and their families. The purpose of student loans is to serve as help for the payment of higher education costs i.e. tuition fees. The basic form of student loans are: federal student loans and private student loans. Most often federal student loans are preferred, because of the lower interest and better repayment terms.
- Mortgages – are a form of loans used for buying a homes. Because of consumers’ inability to pay the price of the home in full at the time of buying the home, they are in need of additional funds. These funds are obtained through a mortgage loan. You should know that mortgage loan is associated with your home, thus failure to meet your monthly payments could result in foreclosure of your assets (collateral). In addition, mortgages loans are considered to be loans with lowest interest rates. There are different types of mortgage loans you should be aware about.
- Auto loans – have similar characteristics with mortgage loans, in terms of the need for collateral. In other words, auto loans are tied to your property (most often the vehicle you will purchase). Failure to meet your payments, could result in loosing your vehicle.
- Personal loans – are loans used for various (as the name suggests) personal expenses and/or needs. This type of loan is not approved for some specific reason, as it was the case with mortgage or auto loans. Personal loans can be used for repaying your outstanding debt (most often credit card debt), aiming at reduction of the interest rates though balance transfers. The terms for approval of these loans are tightly related to borrowers’ credit score. Personal loans represent an unsecured loan. Make sure that you know the things you should consider before applying for a personal loan.
- Payday loans – are short-term loans, characterized with high interest rates. These loans are usually used to overcome short-term cash flow problems. Payday loans come with certain benefits and drawbacks.
- Consolidation loans – are loans commonly used to better manage your finances. You are taking this type of loan to consolidate all (or most) of your debts into one single loan, and one single monthly payment. You could also get a better deal in terms of lower interest rate.
- Home equity loans – if you have some portion of equity in your home, it means that your home is worth more than you owe on it. This difference, called equity, can be used for paying more costly projects. For this reason, they are used for renovating your home, consolidating debt, etc.
- Home equity lines of credit (HELOC) – are somewhat similar to the home equity loans, since they both use the equity in your home as a mean of loan guarantee, thus having lower interest rates. The difference between the aforementioned type of loan and HELOC is in the repayment terms as well as the type of interest rate. That is, home equity loan is characterized with fixed interest rate and regular payments. On the other hand, HELOC is consisted of a variable interest rate and flexible payment schedule.
After you got acquainted with the different types of loans, you should be able to identify the most appropriate loan which will serve your needs in the best manner. Understanding different features of different types of loans would make the shopping for loans much easier. In addition, you should always know our rights as a consumer. You can apply for loan for the purpose of buying a car, purchasing a home, paying your tuition fees, renovating your home, etc. There is a wide range of loans available to cover different needs. Thus, for the purpose of ensuring safe lending practices and eliminating the possibility for manipulation of borrowers, a federal guidelines have been set in place. In that manner, you should know that irrespective of the type of loan and its repayment terms, every loan is overseen by state and federal guidelines for the protection of consumers. If you think that you have been manipulated or misinformed, then feel free to check your rights at the Federal Trade Commission.