Loan Types

Whatever a given lender may tell you, when you are looking to borrow money, it pays to shop around and explore at least two different borrowing sources as well as all the various terms and conditions of the loans. Here are key concepts to pay attention to:

A. Annual Percentage Rate (APR)

If all else is equal, you want to choose the loan that offers the lowest interest rate. The interest rate offered on loans can vary widely, especially on mortgages or private school education loans. A standard way to compare the rates you’ll be charged on a yearly basis is to check the annual percentage rate (APR). Also be sure to check that the APR does not expire after a certain time period.

You should know that interest payments may not be the only cost of borrowing. Be sure you are aware of all fees associated with taking out a given loan and whether or not those fees are included in the APR calculation. Note: Different lenders may use different formulas for computing the APR.

B. Fixed- vs. Adjustable-Rate Loans

There are also some important differences between fixed-rated loans and adjustable-rate loans. On a fixed-rate loan, the interest rate that is agreed to at the start of the loan will remain the same through the time span of the loan. It is usually fixed close to the market interest rate at the start time and is an option that makes sense when interest rates are rising. Adjustable-rate loans, on the other hand, change according to the market interest rate. Generally speaking, they make sense when market interest rates are declining, so that your interest rate will also decline over time. But interest rates can also rise and it’s important to assess your ability to pay the interest over the full life of a loan.

C. Secured vs. Unsecured Loans

Another choice you’ll make is between a secured loan and an unsecured one. Check out this explanation at Loan.com, but in a nutshell, a secured loan is one in which a borrower’s assets serve as collateral for the money borrowed to buy a house or a car, for example. That means, if the borrower does not pay off the loan on time, the lender could seize what the borrower put up as collateral. An unsecured loan, on the other hand, does not include collateral. Because of this, an unsecured loan is riskier for the lender. It typically has a higher interest rate and is harder for someone with bad credit to get.

D. Balloon Payments           

Be cautious signing up for loans with balloon payments mentioned in the fine print. These long-term loans often have low monthly fees and one large payment at the end of the loan term. The advantage is you will likely get low interest payments over the life of the loan, but you must have the cash to pay the big final payment.

E. Payday Loans

Avoid payday loans. These are loans for a small amount of money – typically a few hundred dollars. It may sound enticing, but the terms can be very tough to meet. Finance charges can add a huge premium to each loan. For example, a $25 charge per $100 lent can make the short-term debt extremely costly. Payday loans can charge more than 400 percent annual interest.

F. Subprime Credit           

You should also be careful with subprime credit. This is credit for people who would not otherwise qualify for loans for, among other things, cars or homes. They might have an imperfect or short credit history. (To find out where you stand credit-wise, click ahead to the Credit Scores lesson.) While it could seem enticing, subprime credit is often tied to less-than-favorable terms, like high interest rates and short grace periods.