What Types of Loans Are There?

You may seek to borrow money for many different purposes. This could be to buy a home, take a vacation or finance a college education. The type of loan you get will depend largely on what the money is for.

There are essentially two types of loans. These are secured and unsecured. The main difference is that the secured variety is backed up by collateral.

Secured loan

A secured loan is so named because there is some sort of collateral supporting it. This is usually property, such as a house or a car.

A mortgage is a perfect example of a secured loan. The amount of money you are able to borrow is based on the value of the home you are buying. In this sense, the house is collateral for the loan.

If you fail to fulfill the repayment terms of your loan, the lender can seize the collateral, in this case your house and sell it to pay off the loan.

A car loan works in much the same way. If you don’t make your car payments, the lender will seize your car and sell it to make the payments.

Other types of secured financing include borrowing from insurance policies and retirement accounts, borrowing from a pawnshop, a business loan and secured credit cards.

A big advantage of a secured loan is lower interest rates. Because the lender’s risk is mitigated by collateral, it does not require as much of a risk premium and therefore charges lower rates.

A big disadvantage is obviously that you can lose your collateral if you don’t fulfill the repayment terms.

Unsecured loan

An unsecured loan is a loan with no collateral backing it up. Credit cards, lines of credit and personal loan agreements are all examples.

An unsecured loan typically will carry a much higher interest rate than a secured loan because the risk of non-payment is higher. The lender is simply taking you at your word that you will pay the money back.

With no collateral to lose, borrowers are more likely to default, while the lack of collateral makes it much harder for the lender to recoup its money.

On the other hand, an unsecured loan is sometimes easier to get than a secured loan. For example, most people can get a credit card simply by filling out an application and going through a credit check. There’s no requirement to provide proof of income.

Unsecured financing may also have more flexible payment terms. This is definitely the case with a credit card, where you can pay as much or as little as you want each month.

Whatever type of loan you are thinking about getting; there are a couple of things you should keep in mind.

You always want to get the lowest interest rate possible. This dictates how much your monthly payments will be and how much you will ultimately pay back.

You also want to make sure your loan has no pre-payment penalties. That way, if you have the ability, you can retire the debt early and save on finance costs.

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