A Little Help in Understanding Loans and Interest
Life is full of challenges and important decisions. Most of these decisions are usually finance-related. Whether you want to go to college, buy a car, get married, buy a home, or even have children, each stage requires you to have your finances sorted.
In most of these cases, you have to take a loan to finance the expenses. On average, every American owes around $38,000 in debt, even after excluding mortgage. Taking a loan allows you to pay for heavy expenses at a time when you aren’t in the position to do so. You’re then required to repay this amount over time with interest.
Interest is the fee that lenders charge for borrowing money from them. Interest is the added amount that is worth a certain percentage of the loan. Different types of loans have different interest rates.
There are two main types of loans; Secured loans and Unsecured loans. We’ll discuss them in detail in a bit. Let’s first go through the common terms and phrases associated with lending to get a better understanding of your personal finances.
Some lending options have the condition of providing collateral, that’s why it's important to understand this term. Collateral is any property, asset, or valuable item that you designate as a backup for your loan. So, if the borrower can’t pay back the loan, the lender can take the collateral instead.
For instance, a car loan usually has a new car as collateral. So, if you don’t pay back the car loan, the lender can take away your car.
· Interest rate
Interest rate is one of the primary factors that you should be mindful of when applying for a loan. The interest rate is the fee that you pay for borrowing the money. For example, if you take out a loan of $10,000 with the interest rate of 10%, then you’ll be paying back $1000 in interest in addition to the loan over the period of the loan.
o There are two types of interest rates. Let’s learn about each of them below:
Fixed-rate: Fixed-rate means that the interest rate wouldn’t change throughout the period of your loan. Fixed rates are easier to manage because you know exactly how much you’ll have to pay over time.
Variable-rate: Variable interest rate means that the percentage can change throughout the lifespan of the loan. So, your payments could increase or decrease each month. These interest rates usually have a cap, which means that the rate can’t go above a certain percentage.
Types of loans
There are two broad types of loans. Let’s understand them in detail below.
· Unsecured loans
Unsecured loans are the type of loans that do not require collateral. So, you must agree to repay the loan without any attached backup. Because of the uncertainty of loan repayment, the interest rate is usually much higher on these types of loans. Some lenders also charge additional fees for unsecured loans.
When you apply for an unsecured loan, we will ask you to provide a lot of personal information to determine your financial health. We use this information to determine how much money would be reasonable to lend to you. We run a check on your credit history and financial standing. Based on this extensive information, we decide whether we’ll lend you the money or not.
If we approve your application, you have to agree to pay back the loan with interest and during a set period. There are many types of unsecured loans. Some of them are as follows:
Personal loans are usually unsecured. They also come with no conditions on how to spend the funds. You can use personal loans to finance any step in your life, such as home renovations, going on a vacation, getting married, starting a business, etc. Before agreeing to the terms of a personal loan, make sure that you’re aware of the monthly installment that you’ll have to pay. Accept a monthly payment amount that you can pay within your budget each month.
Student loans are also often unsecured. However, the unsecured student loan usually has the requirement of a co-signer. Someone who has an excellent credit score and history and whom you know personally should be your choice. A co-signer is someone who takes responsibility for making payments if you can’t do it.
Although credit cards aren’t usually considered as a typical loan, they are also a type of unsecured loan. With a credit card, you borrow a particular amount when making a purchase on the card. Then, you have to pay this amount back with some interest. Almost all credit cards come with a spending limit. Overspending on credit cards is the most common reason for ending up in major debt.
Debt consolidation loan
If you have multiple high interest and unmanageable loans, you can combine them all into one convenient loan for some credit card relief. This is called a debt consolidation loan, and it won’t help you erase debt but it helps you pay off your debt and avoid falling into a debt trap.
· Secured Loans
Secured loans are the types of loans that require collateral. Since you’re putting an asset on the line, these loans come with a lower interest rate than unsecured loans. The types of unsecured loans are as follows:
This is a loan taken to buy a home. In this loan, the home itself is the collateral.
You can take out a car loan, with the car as the collateral.
Home equity loan
This loan can be taken for several reasons. In this loan, the equity of your home, which is the part of the home that you’ve actually paid for so far, is kept as collateral.
There are several types of loans, and each comes with its own conditions, terms, interest rates, and debt ratio requirements. It is essential to understand how loans work before applying for one, so you can make the most well-informed decision in your given situation.
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