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Loans Information |
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Facts You Should Know About Types of Loans
When you set out to borrow, you often come across terms like unsecured loans, revolving loans, adjustable rate loans, etc. While these terms are more or less self-explanatory, it is still useful to be clear on their exact meanings and what they imply before you finalize a loan contract. Unsecured versus secured loans As the name implies, a secured loan is one where you offer some kind of collateral against the loan. The agreement is that if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged. In most cases, this asset would be what the lender has financed. For example, when you take a home loan, you offer the home as collateral. There may also be cases where you may need to offer additional collateral over and above the asset that is being financed. This happens, for example, when the lender is financing close to 100% of an asset that is prone to rapid reduction in market value. In such cases, the lender may insist on your putting up another asset so as to provide a reasonable margin of protection in case of default. Unsecured loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors. In cases where there's a choice available to the customer to take either a secured or an unsecured loan, the former may be offered at a somewhat lower rate. That is, assuming every other factor remains equal. This is because of the lower risk involved to the lender, who has recourse to a specific asset in case you default. However, this situation is comparatively rare in consumer financing, although it is more common in financing businesses. Installment versus revolving loans A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan. You pay interest only on the amount you borrow for the time you borrow it. Sometimes, banks may charge a commitment fee for making a revolving line of credit available to you. This fee is usually charged on the average unutilized amount of your limit. You can also re-borrow the amount you have repaid. In effect, you have a loan that's always available to you on demand. Unlike revolving loans, installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid. Adjustable rate versus fixed rate loans A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you (the borrower) is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan. In practice, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Bear in mind that your current lender may charge a pre-payment fee if you choose to repay before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a switch. An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime (or best) borrowers. The advantage of an adjustable rate (or floating rate) loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable. As a borrower, if you hold the view that interest rates are going to decline, it is best to opt for an adjustable rate loan. But arriving at the correct view consistently is easier said than done. Predicting interest rates is a game where even professional market participants and institutions frequently go wrong. If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. After all, you can refinance it should the interest rates fall significantly. Keeping these basic facts in mind should help you make more informed borrowing decisions. About the Author Prakash Menon is a financial expert and writer specializing in managing personal debt and providing wealth building solutions. He has written on payday loans, personal debt management and other related topics.
MORE RESOURCES:
$2.6 million in loans issued to 16 businesses hit by COVID Evening Observer Business Capital to Facilitate PPP Loans Round 2 GlobeNewswire Traditional Lenders Extended Millions in Loans to the Crypto Space Through Genesis in Q4 Yahoo Finance Updated PPP loan forgiveness applications and rules unveiled Journal of Accountancy PPP Problems: Businesses Say They Got Tiny Loans NBC New York IRS offers option when PPP loan forgiveness is denied Accounting Today Guidance issued for PPP first-draw loan increases, reapplications Journal of Accountancy Pausing Federal Student Loan Payments The White House Taxpayers need clarity on coordination of ERC and PPP loans Journal of Accountancy Loans Still Taking 2 Months to Close as Refi Demand Stays Strong Mortgage News Daily Santa Rosa approves $38 million in loans for affordable housing Santa Rosa Press Democrat Rep. Patti Minter introduces 'Student Loan Borrower Bill of Rights' legislation for the first time WBKO Mountain of Small Loans Looms Over Europe’s Pandemic-Hit Banks The Wall Street Journal Vaccine Critics Received More Than $1 Million in Pandemic Relief Loans The New York Times Connecticut education Commissioner Miguel Cardona says he’ll prioritize student loan debt relief if he’s confirmed as U.S. education secretary Hartford Courant Banks Need a Pickup in Loans to Prosper The Wall Street Journal When Can I Apply for a P.P.P. Loan? The New York Times JCPD: Employee arrested for allegedly embezzling $1,800 from Easy Money loan agency WJHL-TV News Channel 11 OPEC Fund Supports Post-COVID-19 African Infrastructure With $50m Loan to Africa Finance Corporation Business Wire Audit: 'hard to quantify' what state got out of $25 million loan program to venture capital firms West Virginia MetroNews HBCUs receive boost from capital loan forgiveness Inside Higher Ed Rieber lands $15M loan for Aventura mixed-use project The Real Deal Armed Robbery at Loan Store in Parsons KSNF/KODE - FourStatesHomepage.com USMNT boss appreciative of how Sounders handled Jordan Morris’ loan Sounder At Heart Freedom Bank, NVTC to seed $50K revolving loan fund for minority entrepreneurs Virginia Business Magazine Fitch Rates GTT's Priming Loan 'B'/'RR1'; Downgrades First-lien Term Loans; Maintains RWN Fitch Ratings Napa's Loan Ranger, Chris Salese: The GOAT Napa Valley Register Fitch Downgrades ITT Holdings to 'BB+'; Outlook Stable Fitch Ratings Fitch Publishes Jinchuan Group's First-Time 'BBB-' Rating, Rates Proposed USD Notes 'BBB-' Fitch Ratings AI Can Make Bank Loans More Fair Harvard Business Review Types Of Personal Loans Forbes Fitch Assigns Hainan State Farms Investment Holdings First-Time 'BBB+' Ratings; Outlook Stable Fitch Ratings Fitch Assigns SJM Holdings First-Time 'BB+' IDR with Negative Outlook, Rates Bonds 'BB+' Fitch Ratings What Biden’s Election Could Mean for Student Loans The New York Times Secretary DeVos Extends Student Loan Forbearance Period Through January 31, 2021, in Response to COVID-19 National Emergency U.S. Department of Education Expenses used for PPP loan forgiveness: Deductible or not? Journal of Accountancy PPP recipients can apply early for loan forgiveness, SBA says Journal of Accountancy Who owes the most in student loans: New data from the Fed Brookings Institution Home-Equity Loans and Home-Equity Lines of Credit: How They Work and When to Use Them The Wall Street Journal |
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