In simple terms, the definition of a loan is an amount of money borrowed from a person, organization, or financial institution and treated as debt with an interest rate. Learn how to work out interest on a loan here.
In some cases, a loan is provided with collateral in return, ensuring that if the money isn’t paid, an asset will be taken instead. In the case of a house loan, a mortgage will be made as collateral, for instance.
The loan contract between you and the lender specifies what kind of loan it is, what kind of interest it operates by, and the interest amount. It also determines how much you’re going to pay each month and for how long.
Below, we’ll introduce you to the different types of loans, interests, and what makes you eligible for one, including payday loans. Learn what a second payday loan is here.
Types of Loans
Different types of loans are provided for different purposes, and the terms for each differ as well. Here are the most common ones. Learn how to pay your loan off faster here.
Secured loans are those that include collateral in the agreement. The collateral is usually an asset owned by the borrower, which they present to the lender. Learn what is a secured loan here.
This type of loan is taken if the amount borrowed is large, so the bank wouldn’t be able to lend a large sum of money without guaranteeing that the money will be repaid in due time. For instance, mortgages and car loans are secured loans. Learn what is bank loan here.
Generally, secured loans have low interest rates and long repayment times since the bank is ascertained that the money will be repaid or the collateral will be acquired if the borrower defaults or doesn’t pay. Read more about loan payment formula here.
Opposite to secured loans, unsecured loans don’t include collateral. Instead, the bank grants an amount of money to borrowers at an interest rate.
How they work is that the bank goes through your financial information to determine if they can lend you the money or not, then when everything checks out, you get the money. Learn how to apply for a loan here.
Interest rates are quite high with unsecured loans due to the higher risk of default the bank faces. With no guarantee of repayment without legal action, the bank has to increase the interest rate to get back as much of the money as possible. Learn what happens when you default on loans here.
Types of Unsecured Loans:
- Credit cards
- Education loans
- Personal loans
Revolving and Term Loans
Other ways to categorize loans are based on whether they’re revolving or term loans.
Revolving loans are when you borrow more money on top of your existing loan, and you can either pay it in full or partially before borrowing again. An example would be credit card loans, where you have a credit line at your disposal up to a specified limit.
With term loans, you can’t borrow money on top of your existing loan. You’ll have to start the loan process from scratch and pay it off in equal monthly instalments. Home loans and education loans are the most significant examples of term loans.
As we’ve mentioned, interest comes in its different forms as well. Precisely, it could either be a simple interest rate or a compound interest rate. It’s essential to know the difference before applying for a loan.
With simple interest rates, the interest is applied to the principal loan amount. The borrower is required to repay the full amount plus a set percentage. However, banks don’t usually apply simple interest to loans. They typically apply a compound interest formula instead.
Compound interest is basically interest on interest, which means that the interest isn’t merely applied to the principal loan amount but also the accumulated interest of the past duration. In this case, the bank initially sets a percentage that’s added to the loan amount, and with each year that passes, another percentage is added above the existing one and the loan amount.
What to Consider Before Applying for a Loan
When you apply for a loan, several factors determine whether the bank will approve it or not. Learn how long will it take me to pay off my loan here.
Your credit score is a significant factor you need to consider. Banks tend to approve loans for those with a high credit score since it guarantees the borrower has a history of paying their debts on time.
The size of the loan depends on your monthly income. This is because the bank needs to make sure that you’ll be capable of paying the amount without them risking their money and at the same time, they don’t want you to be put under financial pressure.
A reasonable income isn’t enough if your monthly expenses take most of it away. The bank needs to know that you don’t have too many obligations before approving a loan to ensure that you’ll still have enough money each month to repay them. Learn the payday loans definition here.
At this point, you should have a well-rounded overview of different types of approved loan. To recap, a loan is a sum of money borrowed from a financial institution and repaid in a set period of time with interest. Loans come in different types, including secured, unsecured, revolving, and term, and so does interest, which is either simple or compound. Read more about paid default loans here.
Before you apply for a loan, check your credit score, income, and monthly expenses to make sure that you’ll be able to get that loan approval process and will be able to repay it without causing yourself too much of a hassle. Discover the answer to can you get a loan at 17 here.