Types of loans
Understanding the differences between certain terms and types of loans is a big help when you're ready to borrow. For instance, if you buy a house or a car — two of the most common reasons you might take out loans — your loan is secured. A secured loan means that you guarantee the loan with some collateral. If you don't make payments and default on the loan, the lender can repossess the collateral — your house in the case of a mortgage, or your car in the case of a car loan.
An unsecured loan — sometimes called a personal, signature or note loan — on the other hand, isn't guaranteed by any collateral. Your promise to repay is the only basis on which the lender makes the loan. Since the lender is taking a bigger risk, the interest rate may be higher, or you may be asked to find a cosigner who agrees to pay the loan if you default.
The term of the loan
Whether your loan is secured or unsecured, it will have a term, which means how many months or years you'll have to repay the loan. The longer the term, the smaller each payment will be. But the tradeoff is that the longer you take to pay the money back, the more you'll pay in interest. You'll have to weigh the extra cost against how much you can comfortably afford to pay each month.
For example, if you take out a $20,000 car loan, you may be able to choose between a 36-month and a 48-month term, both assuming you pay 8% interest.
|
Number of months |
36 |
48 |
|---|---|---|
|
Monthly payment |
$626.73 |
$488.26 |
|
Total of payments |
$22,562.28 |
$23,436.48 |
|
Total interest paid |
$2,562.28 |
$3,436.48 |
Adjusting the rate
You may be able to choose whether your loan has a fixed or an adjustable interest rate. Fixed-rate loans mean you'll pay the same interest rate for every year of the loan. Adjustable-rate loans, on the other hand, charge an interest rate that can change periodically. An adjustable loan's rate is pegged to a particular index, or nationally published interest rate that changes regularly. That rate plus the margin, or the number of points above the index that your lender charges, is your interest rate. Different lenders use different indexes and margins, so all adjustable loans don't cost the same, even if you borrow the same amount.
