You can face different situations in life like buying a new house or a new car and the like when you will need to take loans from any financial institution or any friend or any relative. A loan is a certain amount of money which you receive from a relative or friend or any financial institution in exchange for a promise to repay the principal plus interest. Here, the principal is the certain amount of money you borrowed, and the percentage charged on the principal is the interest. You often prefer to ask for a loan from friends or relatives because then you may not require paying any interest.
Types of Loans
Different types of loans are available in the world, here we have chosen the most important ones among them:
Each of the types is described below:
The loans which you may borrow again and again are called open-ended loans. There are some open-ended loans which are the most common of its types such as lines of credit and credit cards. These loans both have a limit of credit indicating the maximum amount which can be borrowed at a time.
All or part of the credit limit can be used depending on the need of the borrower. Every time a purchase is made, the available credit decreases. When the borrower makes payments, the available limit increases allowing her/him to use that same credit again and again if s/he abides by the terms.
One-time loans are called closed-ended loans because you cannot borrow them again once you have repaid them. The balance of the closed-ended loans decreases with each payment of the loan. There is no available credit limit which can be used on closed-ended loans. If it becomes necessary for you to borrow more money, you must apply for a second loan and need to pass through the process of approval again. Mortgage loans, student loans, and auto loans are some common examples of closed-ended loans.
Mortgage loans are the best options for the people who want to purchase their first home or any other type of real estate. The home or property the borrower is buying is the security for these loans. So, if the borrower is unable to make timely payments, the lender or financial institution is entitled to take your home or property back. These loans can be structured in different year terms such as 5, 10, 15 or 30 years. The payable interest is tax-deductible and lower than other loans.
Student loans can help finance college or varsity education. The payable interest rates are quite reasonable, and the students don’t require to pay back the loan while s/he is a full-time college or varsity student. The drawback of this loan is that the loan can be accumulated to over $100,000 or Tk 80,00,000 during 4, 6 or 8 years. This may lead new graduates with vast debts as they begin their fresh careers.
Auto loans are connected to the borrower’s property. These loans can help the borrower afford a vehicle, but s/he risks losing the vehicle if s/he misses payments. A bank or the car dealership directly distributes auto loans. The loans distributed by the dealership are more convenient, but the associated interest rates are much higher.
The loans that are backed by collateral which is an asset are known as secured loans. The lender can possess the asset and use that for covering the loan if the borrower becomes a loan defaulter. Secured loans are with lower interest rates than the unsecured ones. You need to appraise the asset to know its value before borrowing a secured loan. The lender may lend you only up to the asset’s value. A title loan or a car title loan is a kind of secured loans.
In case of a title loan, the vehicle title is used as collateral by the borrower. The loan company or the lender will lend up to twenty-five percent of the total value of the car and will possess the car’s title if the borrower defaults.
Sometimes small business loans are secured loans and the borrower must pledge any specific kind of personal asset as collateral. Any local banks can offer these types of loans to people who are going to start a new business. These loans have a little more formality than other loans and the borrower may require showing a business plan to prove the validity of his business plan.
No asset as collateral is needed for unsecured loans. These loans are with higher interest rates and borrowers cannot get it easily. The borrower’s credit history and her/his income are the only qualifying facts for the borrower. If the borrower defaults, the lender must go through all collection options for recovering the loan like debt collectors and a lawsuit. Sometimes personal loans are unsecured loans and a borrower can quite easily get it if s/he has an average credit history. The drawback of personal loans is that these loans are generally for small amounts, not more than $5000 or Tk 420,000 (approximately).
Mortgage loans are sometimes called conventional loans. Conventional loans are not insured by any government agency such as the Veteran Administration (VA), Rural Housing Service (RHS), or the Federal Housing Administration (FHA). Conventional loans can be conforming or non-conforming. Where conforming loans follow the guidelines set by Fannie Mae (The Federal National Mortgage Association) and Freddie Mac (The Federal Home Loan Mortgage Corporation). Non-conforming loans don’t follow these guidelines.
Loans to Avoid
You should avoid some types of loans because of their exploitative nature. Payday loans are one among those. These are short-term loans and the borrower’s next paycheck is used as the loan’s guarantee. The APRs (Annual Percentage Rates) are notoriously high for these loans and so the borrowers can face difficulty to pay off. If you are going through a financial hardship, you should seek alternatives before going for payday loans.
Advance fee loans which are not actually loans at all are scams for tricking the borrowers to pay money. These loans apply different tactics for convincing borrowers for sending money for obtaining the loan. But the main motive of the lender is to collect an upfront fee from the borrower for obtaining the loan. Once the lender receives the money, they will typically disappear without ever giving the loan.