Loans are a financial tool millions of consumers use to finance big expenses that cannot easily be covered with cash on hand. Lenders make loans available to all sorts of borrowers, from those with less than perfect credit to those with a spotless credit history, but it is important to understand how loans work if you want to make the most of borrowing money.
Being educated on the various types of loans offered as well as the basic mechanics of all loans is the first step toward using loans to your benefit.
Types of Loans
Before diving into loan basics every borrower should know, it’s helpful to know what a loan is. The simple definition of a loan is the process of giving or receiving money in exchange for payment in the future. Most loans are made through financial institutions, like banks and credit union, but a loan may also be from a family member, friend, or colleague.
There are several types of loans available to borrowers, including easy access loans, traditional personal loans, and secured loans. Easy access loans are typically offered by non-conventional lenders, including online providers and local companies, and they are specifically designed for borrowers with less than perfect credit.
Online loans or local car title loan Sacramento offer a wide range of repayment lengths, amounts, and fees, but these options are beneficial to those who cannot qualify for a more traditional personal loan.
Banks and credit unions, along with some online lenders, offer traditional personal loans. With a personal loan, the financial institution offers a well-qualified borrower more favorable loan terms because they are viewed as a lower risk to the lender. Personal loans are available for amounts ranging from $1,000 up to a few thousand in most cases, and repayment can extend up to five years depending on the loan amount.
Secured loans are another common loan type. Unlike personal loans, secured loans require some type of asset to tie back to the loan, in the case the borrower defaults on repayment. An asset used to secure a loan may be a home, for a mortgage loan, a vehicle, for a title or auto loan, or a savings account, for a bad credit loan. Repayment terms, total cost, and amount are mostly dependent on the asset used to secure the loan.
The Mechanics of a Loan
In addition to the types of loans available, it is important for borrowers to understand basic loan terms, including:
Repayment term: the repayment term of a loan is the amount of time given to a borrower to pay back the original loan amount, plus interest charged on the loan. Most loans have repayment terms ranging from one to five years, but larger loans, such as a mortgage loan, may extend as long as 30 years.
Interest rate: the interest rate is the percentage of the loan amount charged for borrowing the money. Interest rates vary greatly from loan to loan, depending on the creditworthiness of the borrower, the amount of money borrowed, and the length of the repayment term. Essentially, interest is the cost of borrowing money.
Collateral: any asset used to back a loan, such as real estate, a vehicle, or a bank account, is known as collateral.
Default: when a borrower fails to repay a loan as they agreed to, they are said to have defaulted on the loan. When this happens, the lender can take ownership of any collateral pledged toward the loan, report the default to the credit bureaus, or both.
Understanding the ins and outs of loans is a necessary part of being financially savvy. Take the time to learn about the different types of loans along with the basic terminology of loans to ensure you’re making the right decision when loan funds are needed.