Know What Type of Loan you Need

September 6, 2008

There are many different types of loans available. Before you borrow money, you need to know what type of loan you will be looking for.

Most loans are self-explanatory. Their titles tell you what type of loan they are. But you should be very clear before you sign the dotted line.

A secured loan is one in which there is collateral of some kind put up for the loan. This can be anything from a vehicle loan, a boat loan, a mortgage or business equipment. If you dont pay the loan, the lender has the right to take the collateral. In most cases, this is the item you have bought with the financing.

Some people have to offer additional collateral to secure a loan. For example, when the lender is financing 100% of an asset that will have a rapid reduction in market value, he may ask that you put up another asset to add to the collateral value of your loan.

An unsecured loan has no collateral. It is based on your credit standing, your income and other factors. Most secured loans have a lower interest rate because the risk of default is lower.

A revolving loan is one where you have access to a continuous source of credit, up to a set credit limit. These loans include credit cards and home equity lines of credit. For example, if you have a $10,000 credit limit, you can charge it up, pay it down and charge it up again. You are only charged interest on the amount you have borrowed from the credit.

Installment loans have a fixed repayment schedule. You borrow a set amount of money and have a fixed repayment schedule and payment amount. You cant take more money out from the loan. Once it is paid, it is paid.

Fixed-rate loans have a fixed interest rate for the life of the loan. You are protected from changing interest rates. You know that your rate and payment will remain the same over time. This is a great advantage to home buyers and other loan borrowers. However, if rates fall, you will lose out on lowered rates. You will have to refinance to take advantage of the lower rate.

The adjustable-rate loan has an interest rate that rises and falls with a benchmark rate, usually the Prime Rate. The advantage of an adjustable rate is that you could pay less in interest if the rate falls. In many cases, adjustable-rate loans have an initial interest rate that is lower than a fixed-rate loan. But the disadvantage is that this rate could adjust upwards. When the rate goes up, the monthly payment amount will as well. This can make the future unpredictable for a borrower.

Before you set out to borrow money, you need to know what type of loan fits your financial needs. You should also know how much you can afford to borrow, both in monthly terms and over the long term. When comparing different lenders, make sure that you are comparing the same types of loans with the same terms. For example, if one lender quotes you a fixed-rate interest rate and the other quotes you an adjustable-rate interest rate, you are not only seeing a difference in rates, but also very different types of loans. Know what you are agreeing to before you borrow money.

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