If you’re one of the 80% of Americans currently in debt, you don’t have to worry about being alone in your frustrations. However, it’s often necessary to take out loans to get to our larger financial and life goals. If you know the basics of the most common types of loans, you’ll be able to get the one that suits your needs the best.
Here are four types of loans you should know more about.
1. Unsecured Loans
If you’re applying to get a loan or thinking of getting one, this is probably the first loan you’re going to try for. When you’re applying for loans, the concept of a secured loan has to do with how your loan is backed up. Theoretically, a loan is backed up by your interest in not ruining your credit combined with your current income.
When you apply for a typical home or auto loan, you’re not usually putting down any kind of collateral. That means that you’re getting an unsecured loan. If you were willing to secure the amount of another loan with your car or house, you’d find that the interest rates are going to be lower.
Collateral is the major difference.
With unsecured loans, you’re going to have some predictable payments that are easy to figure out. You’ll get a lump sum at the start of your loan and then you’ll have a set payment month after month for the length of the loan. You’ll be paying a loan that’s sometimes called an installment loan.
The only problem with this kind of loan is that you’ve got to have good credit. If you don’t have something in the upper 600 to 700 range, you’ll struggle to get a loan that’s at a good rate. If you do, you’ll be approved quickly and be able to negotiate your interest rate.
2. Secured Loans
As mentioned above, the concept of a secured loan is dependent on collateral. That’s what you’re willing to put behind the loan to prove you can pay it. If you take out a $1,000 loan and back it with a $20,000 vehicle, the lender knows that they could potentially seize your vehicle and sell it to recoup payment.
While this isn’t ideal, it’s vital for people who have poor credit. If you have a lot of powerful assets but bad credit or no liquidity, secured loans are great for you. Secured loans offer a solid lending path but with a lower interest rate than you’d find with unsecured loans.
Interest rates will be much more competitive when you get a secured loan. Backed by collateral, banks are going to feel much more confident in the money they’re lending to you. They’ll know that there are still ways to recoup their money if everything goes haywire.
Secured loans are going to mean that you’re taking on a risk that the bank isn’t. You’re putting something valuable on the line for this loan. If you find you’re taking out a lot of secured loans and can’t seem to get a secured one, try building your credit after a while.
3. Fixed-Rate Loans
When you’re applying for a personal loan, you might not worry too much about the interest rate changing. If the loan is just for a year, it’s not going to fluctuate much in that time. However, if you’re getting a long-term loan, like a home or car loan, you’re going to be dealing with fluctuating rates that change as the economy changes.
Most personal loans are fixed rates, but if you want to get a better deal on your home loan, look for a low fixed-rate rather than variable.
With fixed-rate loans, you might pay slightly more than the current interest rate but you’ll never go beyond a certain threshold. It’ll be easier for you to plan out your finances and to budget with a fixed-rate loan. You’ll know exactly how much you owe each month and to be able to plan for bigger expenses.
The lender is the one taking on more risk when you apply for a fixed-rate loan. As you’ve seen above, whenever the lender is taking on risk, you’re going to pay more for the loan. If rates go up, they’re not exactly losing money but they’re making less than they could.
4. Variable-Interest Loans
This is the inverse of the above type of fixed-rate loan. It does exactly what’s written on the tin. If you’re on top of the financial industry and love to look at the way that interest rates change over time, you’ll appreciate this type of loan.
Your interest rate is going to change over the life of your loan. You’ll watch as politicians even talk about how the federal lending rates are changing and what it means for you. With a line of credit, you’re more likely to be subject to a variable interest rate.
Some lenders are going to allow you to borrow up to a certain amount as long as you consent to this variable interest rate. You might find that you can have a higher ceiling if you agree to a variable rate.
Make sure you only borrow as much as you need. Each dollar that you borrow is going to cost you more over time. While you’ll make monthly payments, the interest is going to keep climbing and make it harder to pay back.
Fluctuating rates dance with the bigger financial market. You might even have fees attached to your loan, so make sure you’re not getting taken for a ride on fees.
If you need a better walkthrough, check out what Bonsai Finance offers to find out more.
There are Even More Types of Loans
With all of the types of loans available, there’s bound to be something that meets your financial needs. While it’s confusing and overwhelming to plan so far in advance with some types of lending, it’s helpful to getting you where you want to be in life.
If you’re considering a debt consolidation loan, check out our guide to find out more.