Loans come in all shapes and sizes, from ‘I owe yous’ between family and friends to complex home loans, car loans, Home Equity loans, Small Business loans, payday loans and student loans …the list is almost endless.
Its important to have a basic understanding of each type of loan as some life event could require you to have a need for some cash urgently or just a need in general. You may need a new car or want to buy a house or renovate you existing house or start at a colleague and further your education. What ever the need, a basic understanding of the loans out there will only help you in the long run.
This brings me to the subject of this article: Loan Types Explained.
Let’s get started.
Open-Ended Loans vs Close-Ended Loans – They’re either 1 of 2
Loans fit into one of two broad categories, Open-Ended or Closed-Ended Loans. So what’s the definition of each?
- Open-Ended Loan
You probably have an Open-ended loan right now, but it is not known as that.
These loans allow you to borrow as much as you need withing a predefined limit. You then have to pay back all the loan that you have taken or part of the loan on a monthly basis.
Yes, that’s it, the most common Open Ended Loan is a Credit Card. Although most people don’t think of a Credit Card as loan, it actually is. With a credit card you have the option to spend the money on whatever need you require. You can choose to spend all of it up to your limit or just a small bit of you limit.
Each time you pay back on you credit card or loan you have the option to spend more on the card again. The amount you pay back can be used once again as required on anything you need to pay on.
With Open-Ended Loans be wary of loans with variable interest rates, as these rates fluctuate with the market Index and you can find yourself paying a lot on interest if rates go up.
- Closed-Ended Loan
These loans are the traditional loans that most of you are aware of in the day to day. Loans like a Car Loan, Home Loan, Student loan, Business loans etc.
With these loans you are exactly sure of how much you are borrowing and when you need it to be paid off or completed. The term ‘Installment loans’ is often used to describe these loans. You Borrow and then pay back in monthly installments. Once you have completely paid off you loan you will need to re-apply for another loan. Unlike the Open Ended Loans or Credit Card, which when you pay it down you can re-use your Credit limit.
Another aspect on these loans is that when you complete the payment on the loan and need another loan you will have to go through the same application process as you did for your first loan. You will need to pay the Loan Origination Fee or Establishment fee once again and that can be costly.
Fixed Rate Loans vs Variable Rate Loans
There is no complexity here when it comes to describing the Rate of you loan. It is one of two types.
- Variable Rate Loan
The most common loans that have variable interested rates can include, but are not limited to Home Loans, Car Loans Student loans
With a variable interest loan you are at the mercy of the market rate or index. If the market index goes up your loan rate will go up as well. If the index goes down you will follow suite. Banks are super quick to raise rates with an index increase, but tend to take their time to lower them when the market rate or index goes down.
- Fixed Rate Loan
The most common loans that have variable interested rates can include, but are not limited to Home Loans, Car Loans Student loans.
The fixed rate loan is exactly that. The rate is fixed for the term of the loan and will not fluctuate with the market. This is why it can be a good idea to lock in a fixed rate home loan whenever they talk about historically low interest rates. You can get a low rate for the duration of the loan.
Secured Vs Unsecured Loans
- Secured Loans
These loans required you to put something up as a guarantee or as collateral against the loan in the event that default in the loan. By putting an asset up the lender has the ability to retrieve some value back by way of your assets.
These loans are often seen with Home and Auto Loans or Small Business loans. If you default the lender can foreclose on your house or take possession of your car or Business assets
- Unsecured Loans
These loans do not require you to put an asset up as collateral and are the common type of loans for student or personal loans.
In general the unsecured loans have a higher interest rate and will hit your credit history to help the lender determine if you are a safe prospect and or what interest rate they can offer. If you have poor credit it will be difficult to be funded with an unsecured loan.
Students, if you have poor credit the best opportunity is going with a Federal loan which does not look at your credit rating.
I have covered a few topics when it comes to student loans already on Findaloan247. If you need financial assistance for school or College and don’t have the means to pay the tuition fees then you will need a financial vehicle to get some money to further your education.
Students have two avenues to look at, Federal Loans and Private Student Loans. Federal loans are fixed loans and offer a massive number of benefits to the students especially when it comes to relief. These generally have a lower interest rate than the private student loan option.
Private loans, if you don’t have enough funds from Student aid or the Federal government you will need to top up with a private loan. Be really diligent when it comes to private loans. Look long and hard at the rates and loan duration to know exactly how much it is going to cost and what the repayments look like.
Mortgages or Home Loans
Most of us, myself included have mortgages. Unless you have heaps of savings and make serious dollar you will need to take out a mortgage or home loan in order to purchase your home.
The Bank will lend you money, if you qualify for one in order to purchase the home. These can be fixed or variable interest loans.
They are secured loans meaning, if you default the Bank or lender can collect on the loan and foreclose on your home to retrieve some money lent to you. Home Loans will affect your credit and you Credit History is also checked on application.
Home Equity Loans
Let’s say you purchased your house for $100000 and over the course of 10 years you have paid back $50000 , leaving you $50000 owing. Now, if the value of the house has increased by $50000 making you house worth $150000 you have equity in the asset and you can leverage this to obtain a loan.
Home equity loans are good for needs such as renovating the house, consolidating credit card debt or paying off student loans along with other necessary items that occur in life. College paysoffs, Medical Bills etc.
Home equity loans and home equity lines of credit (Helocs) use the borrower’s home as a collateral so interest rates are considerably lower than credit cards.
The major difference between the two is that a home equity loan has a fixed interest rate and regular monthly payments are needed. HELOC loans have variable rates and have a flexible pay schedule. These are secured loans so you be sure that you have a good payback strategy.
These type of loans are an attractive option for people with outstanding credit card or other debts. The loans enable to pay off high interest loans that could be creating financial anxiety.
Personal loans can be used for any personal expenses and are not tied for use for a specific expense or purchase.
Refinancing and Consolidation Loans
I talked about is in another article , specifically directed at students who may want to investigate loan Consolidation or Loan Refinacing.
Consolidating loans will merge all your debt into a single loan using a weighted average interest rate.
Refinancing loans will replace one or more loans with a new one. Your terms and interest rates will be negotiated with the new loan. You could use this strategy if you’re struggling to pay high-interest credit card debt or mortgage for example.
Loans to Avoid
There are a couple of loans that should be avoided if you can.
- Payday loans
These are short-term loans borrowed using your next paycheck as a guarantee for the loan. These loans have very high annual percentage rates (APRs) which can affect your payoff ability. Be really care before taking out a payday loans and do you research thoroughly.
- Advance-fee loans
Don’t be fooled in paying in advance for fee to establish a loan. The business selling these loans basically inform you that you need to pay an advance-fee in order to obtain the loan.
It sounds like a scam and the likely result is that you will not hear from again after handing over that fee. Be super careful!
The Basics Covered – Now you are ready to Roll
As you can see there are many loans available and I hope I have given you the high level basics and some useful info to clarify the most common of loans around the market.
Good Luck in your loan search
Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by the financial institution