Table of Contents
- What is a Loan?
- Types of Loans
- Simple and Compound Interest
- Advantages of a Loan
- Disadvantages of a Loan
- Lesson Summary
A loan is money borrowed from a bank or financial institution. The borrower agrees to pay back the principal amount of the loan plus interest. There are several types of loans, including car loans, student loans, and home mortgages.
Although there are several different types of loans which will be discussed below. All loans have several common attributes:
If someone wants to apply for a loan, there are several important steps to follow. These may vary slightly depending on the type of loan, but in general, those steps are:
A loan application is considered a hard credit inquiry and may affect the borrower's credit score slightly.
There are many types of loans, such as personal loans, car loans, and student loans. Even credit cards are considered a type of loan. Generally, they are classified into a few categories.
In a secured loan, the borrower must offer some collateral, an asset that the lender may seize if the borrower fails to make a payment. A home deed is a common form of collateral. Secured loans are usually for a large amount of money. Car loans and home mortgages are common examples of secured loans.
Secured loans have strict borrowing limits, extended repayment plans, and usually, low-interest rates compared to other loan types. For example, if a borrower is seeking to buy a house, the amount borrowed would be the exact dollar price of the house, plus any additional fees, and the term could be as long as thirty years.
An unsecured loan does not require collateral. These a generally shorter-term loans for smaller amounts. Credit cards, student loans, and personal loans are common examples. Since there is no collateral, lenders will often be very thorough in assessing borrowers' financial status.
An open-end loan allows a borrower to repeatedly use a pre-approved amount of money as long as the money is repaid. A credit card is the most common form of an open-ended loan. Based on the borrower's credit score and annual income, the credit card company will determine a credit limit or maximum amount that may be borrowed at any given time. A borrower may then use up to the credit limit. Once the borrower has paid some or all of the amount, they are free to borrow again.
A closed-end loan has a set amount, interest rate, and repayment window. A car loan is an example of a closed-end loan. Unlike a credit card, once the terms of a closed-end loan have been established, they do not change. For example, if a borrower takes out a car loan and then wants to buy a second car a few years later, they would need to apply and get approved for a separate loan.
A conventional loan is a home mortgage that a government agency does not insure. Conventional loans usually require higher credit scores than government-backed loans. They often have higher interest rates and may require mortgage insurance payments.
Simple Interest is the interest calculated on the principal amount only. A simple interest loan will cost the borrower less in the long run. Simple loans are established with equal monthly payments, with a greater portion of the payment paying the interest first and then paying the principal balance. Paying above the established monthly rate, if possible, helps to pay the principal and repay the loan quicker.
Compound Interest is calculated on the principal interest as well as any previously accumulated interest. In other words, you pay interest on the interest. Compound interest can add up quickly if the borrower does not keep up with their payments.
There can be many advantages to taking out a loan. Borrowing money allows the borrower to make purchases they would normally not be able to afford. Some common reasons for taking out a loan include:
Loans sound like a great way to get extra money, make purchases, and get ahead in life. However, there are some serious consequences to consider if the borrower is not careful.
A loan is money borrowed from a bank or other financial institution. They can be a great way to fund education, make major purchases, or start a business. But they do come with risks, and paying interest means the borrower will spend more money in the long run.
Secured loans require the borrower to provide some asset as collateral, such as a house or a car. If the loan is not repaid, the lender may take possession of the collateral. Unsecured loans do not require collateral.
A closed-end loan has a set principal amount, time frame, and monthly repayment amounts. An open-ended loan, such as a credit card, allows the recipient to borrow money repeatedly as long as they do not reach their credit limit and continue to repay some or all of the debt.
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A loan is money borrowed from a bank or other financial institution. The borrower agrees to repay the principal amount, plus interest. Loans may be secured or unsecured, and they may be open-ended or closed-ended.
One example of a loan is a car loan. This is a closed-end loan, meaning there is a fixed principal amount, term, and regular monthly payments.
There are many types of loans. Some of the most popular ones are car loans, student loans, home loans (mortgage), business loans, and credit cards.
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