LoansFinancial Dictionary -> Loans
The Loan section of Financial Dictionary is one of the most important sections of the site, as many people use loans to buy virtually everything. Most people are familiar with popular loan types like, auto loan, line of credit, student loan, bridge loan, balloon loan, secured loan, personal loan, and mortgage loan. However there are many other important loan related terms that one needs to know. Examples of such terms are amortization, collateral, LTV (Loan to Value), loan term, down payment, loan maturity, loan principal, and prime rate to name a few.
Revolving Credit and Installment Loans
Credit cards also come in two varieties – secured and unsecured, and the former require a deposit which is usually equal to the credit limit. Even though credit card debt has escalated worldwide, one can't deny that having a credit card is very convenient. You will need one to buy something online, book a vacation/flight or simply rent a car. Credit cards are considered revolving credit as available credit goes up and down depending on how much is being borrowed and repaid.
In addition to credit cards, there are other types of revolving and installment credit. Personal lines of credit are one example of revolving credit whereby borrowers are free to draw on the line multiple times and up to the credit limit offered. Installment loans are offered as a lump sum. They usually go with a lower interest rate, especially secured loans because the collateral guarantees timely repayment.
Secured and Unsecured Personal Loans
There are different types of secured and unsecured loans, but the main difference between them is that secured loans are available to customers who offer collateral. The type of collateral depends on the loan, for example, the home itself serves as collateral when applying for a mortgage. Other valuable assets to offer as collateral include vehicles, jewelry, antiques, etc.
Examples of secured loans are mortgages, home equity loans, savings and CD-secured loans, vehicle and title loans, and pawnbroker loans. With title loans, the vehicle itself serves as collateral. Financial institutions accept paid-off vehicles provided that they are in good condition and operational. The most common type of secured financing is the mortgage loan. There are different types of mortgages, including bridge financing, conventional and pre-approved mortgages, 6 month convertible and multiple term mortgages, adjustable rate and fixed term mortgages, and other varieties. In addition to secured financing, banks, online banks, credit unions, caisses populaires, and finance companies offer unsecured loans with different terms, repayment options, and rates. Customers are offered student loans, consumer and auto loans, payday loans, and other types of short- and long-term financing. As a rule, these loans have shorter repayment terms compared to secured debt. The amount offered is also smaller because no collateral is present to guarantee prompt repayment. In this case, financial institutions look at the borrower’s payment history and credit score. Bank clients with very good and stellar credit are offered better interest rates when applying for an unsecured loan. Borrowers with tarnished, less-than-perfect, and poor credit are offered high rates and may be turned down by financial establishments. Customers who offer collateral have better chances for qualifying.
Business loans also come in two varieties – secured and unsecured. Again secured business loans require collateral which can be in the form of vehicle, machinery and equipment, inventory, accounts receivable, etc. Unsecured loans are offered on the basis of business credit rating and come with higher interest rates. This makes them more difficult to afford. They are usually offered to established businesses with a solid payment history. The reason is that they are more risky for financial institutions. Financial establishments usually require collateral, but there are unsecured options for businesses, for example, professional loans, lines of credit, and working capital loans. Businesses have plenty of options when it comes to collateral-based solutions, from hard money equity and franchise start-up loans to equipment financing, business acquisitions, equipment cash out refinance, and others. There are other types of financing that require collateral, for example, secured working capital loans, construction financing, peer to peer financing, and others. These loans vary in terms of transaction size, amount, interest rates, repayment schedule, and other details. The rates also vary depending on the term. Short-term financing goes with higher interest rates. For example, the rate on short-term working capital loans can be as high as 30 percent while working capital financing comes with rates of 3 to 7 percent. The payback term varies widely. Construction financing is a long-term solution with a term of 10 to 25 years. Other types of financing have very short terms. With hard money equity loans, financing is offered over a period of 1 – 2 months. In addition to these differences, businesses apply for financing for different reasons.
Because interest rates fluctuate, some borrowers consider refinancing. For example if the interest rates trend up, then people with adjustable rate mortgage, might consider contacting their creditor and locking in low interest rate for a few years. If rates are going down then a borrower with fixed-rate loan, might consider refinancing in order to save on interest costs.
High-Interest Loans and Predatory Lending
People who have had financial difficulties might be interested in learning about bad credit loans, loan sharks, predatory lending, secured credit cards and of course the always controversial payday loans. Some lenders offer high interest loans in accordance with existing legislation on interest rate caps. There are established payday lenders that offer short-term financing. While the rates are considerably higher compared to banks and credit unions, payday loans help borrowers who need urgent cash. This is sometimes the only solution for debt-ridden borrowers with compromised credit. It is also a short-term solution to cover unexpected or urgent expenses such as utility bills or medical expenses. Unlike reputable providers, there are loan sharks that pray on borrowers and use illegal and unethical practices. Loan sharks typically target vulnerable categories and communities such as single parents, low-income individuals, young and elderly people, and recent immigrants. They also pray on the less educated and those with poor financial literacy and habits. As a rule, loan sharks target borrowers who need urgent or immediate cash. Some lenders falsify information or fail to disclose information to take advantage of borrowers and their money. There are ways to recognize illegal and unethical practices and providers (e.g. aggressive marketing). Loan sharks may try to hinder the customer’s ability to pay off debt.