Finances are complicated, and sometimes you just don’t have the money on hand to do what you need. You can’t be blamed for needing a financial boost from time to time, and sometimes it isn’t enough to simply budget or plan your savings around a large purchase like a house or a car. Sometimes, you just need to take out a loan for what you need. Borrowing money is usually the best or only choice people have to fund larger ticket purchases, such as securing funds for a new business or even funding a dream vacation of wedding. You wouldn’t be alone in needing the extra help; according to experts, a little over half of all adults in America have borrowed money from a bank or lending agency.
Unfortunately, there are many people who don’t understand how loans work, including those in the previously mentioned statistic. Resources to teach people how finances work are shockingly and sadly rare, leading to a general population with a lack of financial literacy regarding how loans work. Did you know that there are several different kinds of loan? It’s okay if you don’t know the ins and outs of how it all works. That’s what this guide is here for: to act as a starting point for learning. Here, we’ll go over some of the basics of borrowing money, including the different kinds of loan and what you can expect in both the short term and long term. If you need to take out some money, you should know what you’re getting into.
Basic Definitions
For starters, all kinds of loans have a few things in common. If you have a grasp on how they work on a basic level, everything else falls into place. The differences are all details and variations on the basics, so that’s exactly where we’re going to start. First, you need to understand what collateral is and how it applies to the money you borrow. Collateral is a solid, tangible thing or asset that you attach to the loan as insurance that you’ll pay back the money you borrowed. Money that has collateral attached to it is called a secured loan, and is generally safer for a bank or lender to work with. Often, secured funds are dictated by what you’re borrowing for, and failure to repay means that the lender can legally take the collateral. The most common examples are homes and cars, both of which are collateral for a mortgage or auto loan. Conversely, unsecured funds have no such collateral, and therefore usually have higher interest rates to compensate for the added risk.
Interest rates also come in two varieties: fixed and variable rates. A fixed rate is an interest amount that never changes through the life of the repayment period, staying at the same rate for the duration. Variable rates are more involved, and change in response to the overall market surrounding them. They can rise and fall to match the market standard, which is also known as the Prime rate. The Prime rate is a function of dozens of different market forces all intersecting in just the right way to make your life harder. While the rate can fluctuate, as you can see here that usually means that the rate will rise from year to year as inflation and other forces pitch.
To conclude our definitions, we’ll go over revolving credit. This type of loan differs from others in that it isn’t based on a single borrowed amount that you pay back over time. Rather, you are permitted a certain amount of money that you can spend at your leisure, which you are expected to either pay back in full at the end of the billing period or in minimum installments. Consider it like a cup of water that you can take drinks from, only to refill later. The cup represents your credit limit, how much you can actually have at a time, and you are expected to keep the glass full. Instead of borrowing for a single thing, revolving credit like that of credit cards can be used at your discretion.
What is a Personal Consumer Loan?
When you need to borrow money, your most flexible and generalized option is a personal consumer loan, or PCL. You don’t need to have a specific reason to take out a PCL like you would with other more specialized borrowing, such as an auto or small business loan. PCLs allow you to fund anything without a specified terms or purpose. They’re most popularly used for big events, such as vacations or weddings, but are also used for personal projects like remodeling a home. That flexibility comes with a few strings attached, however. Because there’s no standard for a PCL, you and your lender will be negotiating the terms as part of the borrowing process, and those terms almost always favor the lender.
Since they have the money, and therefore the power, they will almost certainly insist on a higher interest rate, probably variable, over a longer repayment period. The longer the life of the repayment, the more interest they collect and therefore the more money they make from the arrangement. By definisjon a PCL has no set limits on these things, so expect your lender to want to get as much out of it as possible. You’ll almost never have to put up collateral for a PCL, which is a nice silver lining to any clouds that you might find.
What is a Student Loan?
Student debt, in addition to being the second most common kind of debt in the country, is the cause of one of the greatest financial crises in financial history. At present, there is $1.75 trillion dollars in outstanding student debt, and that number is only going to increase. Unfortunately, it’s almost impossible to attend school without taking on massive loans to cover the inflated tuition prices. You may be looking at tens of thousands of dollars annually depending on what kind of school you go to.
Student loans are well understood to be predatory, and should be avoided if at all possible. The reason for this is due to the monstrous repayment terms combined with a stagnant wage market. You can see at https://www.boredpanda.com/student-debt-loans that repayment may actually be impossible for a majority of borrowers due to the criminally high interest rates modern banks and lenders offer. Thanks to a high interest rate on a high base principal amount, many graduates are discovering that making payments on their loans not only doesn’t decrease the balance owed, but actually increases the total amount they must repay. This kind of cycle is called balloon debt due to its propensity to increase out of control no matter what the borrower does. This crisis is ongoing, and will likely not be solved any time soon.
What is a Mortgage?
The most prolific debt in the country, both in terms of the sheer amount of it and the number of borrowers, is the mortgage. However, they have several key advantages over student loans, most importantly that they’re actually possible to repay in the first place. That’s a good thing, given that most people will never own a home without taking out a mortgage. In the French, the word ‘mortgage’ translates into ‘death contract’, which many borrowers will agree is an apt description of what it feels like to have one. Given that repayment periods can last as long as thirty years, it can certainly feel like entering one is a lifelong commitment. Don’t worry, though: mortgages are among the most standardized kinds of contract out there, and stand out as one of the most predictable kinds of loan you’ll find.
There are a few elements you’ll find in any mortgage. You can count on them to be secured, as the house you’re borrowing for doubles as the collateral. Whether you pay back the mortgage or not, the bank wins by securing their investment with the home. It’s common for interest rates to start as fixed for a few years before eventually becoming variable; this practice is a standard way of making them more attractive to the borrower. Most notably, the United States government is involved in mortgages, both to insure the banks and to provide extra avenues for borrowers who otherwise might not qualify to take out a standard mortgage.