Understanding Loans

In some ways, of course, all loans are alike. You borrow money, called the principal, and agree to pay it back over a specific term, or length of time, with interest. But the conditions of the loan, some of which are listed below, can affect how much you can borrow and how much the loan will cost you. If you know how different types of loans work and the particular features they offer, you'll be in a better position to look for the one that will be best suited for you.

  • The term of the loan
  • Whether the loan is secured or unsecured
  • Whether the interest is fixed or adjustable

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The Terms of a Loan:

The Loan Agreement
When accepting a loan you are committing yourself to repay on a specific schedule and way.  Those details are spelled out in the loan agreement, or loan note.  When you sign it, you have agreed to its terms and conditions. So it may not be fun, but make sure to look at the fine print. Once it is signed you are obligated to the terms.

 
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Types of Loans:

Secured Loans
Your loan is secured when you provide something of value, called security or collateral, as a guarantee you will repay what you owe. The lender can repossess the collateral and sell it if you default, or fail to repay. Car loans and home equity loans are the most common types of secured loans.

Unsecured Loans
An unsecured loan is made solely on your promise to repay. If the lender thinks you are a good risk, nothing but your signature is required. However, the lender may require a cosigner, who promises to repay if you don't. Since unsecured loans pose a bigger risk for lenders, they may have higher interest rates and stricter conditions. Credit Cards are the most common type of unsecured loans.
 
Installment Loans
When you take an installment loan, you borrow the money all at once and repay it in set amounts, or installments, on a regular schedule, usually once a month. Installment loans are also called closed-end loans because they are paid off by a specific date. Payday or Advance loans are the most common types of installment loans.
 
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Interest Rates:

Fixed Interest Rate
Many loans have a fixed interest rate. The interest rate and the monthly payments stay the same for the term of the loan.
 

Adjustable Interest Rate
An adjustable-rate loan has a variable interest rate. When the rate changes, usually every six months or once a year, the monthly payment changes also.

 

Page last modified March 4, 2014