Oftentimes deciding that you need a loan can be both the easiest and the most confusing part of the entire process. Once you begin your search for the answers you need, you are sure to come across all kinds of options and terms such as adjustable rate loans, revolving loans, and unsecured loans. After a bit of thought, you can often figure out what these terms mean but you are definitely much better off by educating yourself by delving deeper into the meanings and the pros and cons of each before you sign on that dotted line.
Weighing Unsecured Loans against Secured Loans
As you probably already know, a secured loan is the type that is finalized thanks to you providing some sort of collateral to the lender. The idea is that if you end up being unable to pay the loan back, the lender will take over the asset that you chose for collateral, sell it, and apply the proceeds to the remainder of the loan.
More often than not, the asset in question is whatever was purchased with the money that was loaned. For instance, if you agree to a secured loan in order to purchase a car, then the lender could take your car from you if you default on the loan payments at any time during the term of the loan.
In other cases, there may be a need for a borrower to add additional collateral in order to cover the loan, especially if the applicants has a poor credit history or is seen as a higher risk. This can also occur if the asset being purchased is subject to rapid depreciation and the lender suspects that the collateral is not sufficient to cover the balance of the loan.
Unsecured loans, on the other hand, are essentially loans where there are no arrangements for collateral involved. These are the type of loans that are based purely on your credit rating, income, and your previous history and ability to prove you can pay back the loan.
When it comes to certain loans, borrowers are given the option on whether or not they want a secured or unsecured loan. In this case, secured loans are often offered at a lower rate of interest due to the fact that there is much less risk for the lender if the loan goes into default.
Revolving Loans versus Instalment Loans
Revolving loans are often comparable to a line of credit, where you have access to a pre-determined amount of money at any time you wish. For example, you may have a revolving loan where your limit is $5,000. This means that you can borrow as much as $5,000 any time that you want, and then repay part or all of it whenever you choose as long as it falls within the pre-determined length of the loan.
With these loans, you will only pay interest on the amount that you have borrowed for the length of time that you borrow it. On top of that, you can re-borrow the money after you have paid it back, meaning you have access to a loan whenever you determine that you need it. This provides a lot of flexibility for withdrawals and repayments for the borrower.
Instalment loans, on the other hand, come with a repayment schedule that is pre-determined and fixed. You end up borrowing the full amount as soon as the loan is agreed on, and then are required to make steady payments for a set amount of time. Also, you do not have the option to re-borrow any of the money that you end up repaying at any time. Once the loan has been completely paid off, it is in essence then cancelled. If you require additional funds after that time, you will have to reapply for another completely separate loan.
Fixed Rate Loans versus Adjustable Rate Loans
Fixed rate loans can be defined as ones where the borrower is charged a fixed amount of interest for the entire length of the loan. The advantage to this is the fact that your monthly payment always remains the same and that you do not have to suffer if the prime rate ends up taking a turn for the worse. This allows you to have a more structured budget by knowing exactly what your payments are. Of course the drawback comes into play if the interest rate end up falling as your loan payment will remain the same. And since you are locked into a rate, you do not have the benefits from a lower payment if you had agreed to a loan that came with an adjustable rate.
The good news, however, is the fact that you do have the option to refinance your loan if interest rates end up falling enough to make it worthwhile. Just make sure that the refinancing is substantial enough to cover any charges or fees to renegotiate the loan that your lender may hit you with.
In contrast, an adjustable rate loan is the type where your interest rate changes over the length of the term based on a number of factors. The prime rate is usually used as a benchmark and the advantage is obvious as you will be making payments that are in line with the market overall and subsequent shifts that occur constantly. When the prime rate falls, so do your payments. However, when the prime rate increases, your payments will as well. The drawback is the fact that you can never be exactly sure what your monthly payments will be, so it can be difficult to budget and stay in a routine.
If you have the feeling, or have good advice, that interest rates will fall in the near future, then your best bet is to choose an adjustable rate loan. However, as we all know it is quite difficult to make the best decision all of the time and trying to predict interest rates is a game where even the experts make miscalculations and are embarrassed from time to time.
With this base of knowledge when it comes to the varying types of loans, you should be much more prepared to make an informed decision when borrowing money for your next purchase. Of course, there are far more options and a dizzying array of lenders that you can turn to, so just be sure to stay informed and educate yourself as much as possible beforehand.