What Are Loans?
A loan is a term that is familiar to an average person. When people find themselves in situations where they need to meet certain needs but they do not have the financial capability to do so, one of the options they resort to is to apply for a loan. Simply put, A loan is the debt of a person or an entity. The lender usually provides a borrower with a sum of money, in exchange, the borrower agrees with certain terms and conditions set by the lender, which may include any finance charges, interest, date of refund, and other conditions.
Where can you get a loan from?
There are three major channels through which you can get a loan
- A corporation
- Financial institution
Types of loans
There are two major types of loans, which are secured and unsecured loans
Secured loans – These are loans made in exchange for the disposition of a specific asset known as security. In loan terms, security refers to the lender’s temporary ownership of the asset pledged as collateral by the borrower. This is a common type of loan, particularly when a person needs to borrow a large sum of money. A lender will loan large sums of money if the borrower makes a promise to repay the loan in the future (with interest, if applicable) and provide required collateral, such as a house or car. From the borrower’s perspective, secured loans are significant because they enable the borrower to obtain loans and repay them under favorable terms.
What happens if a borrower fails to pay a secured loan? The borrower may be unable to repay the loan due to an unforeseen circumstance or, in some cases, by choice. In this case, the lender has the necessary security to liquidate and secure his money by selling or acquiring complete ownership of the borrower’s collateral.
Examples of secured loans
Loan for Recreational Vehicles – A recreational vehicle loan is a loan used to finance the purchase of a motorhome.
Mortgage loan- it is a loan used to finance the purchase of a house.
Home equity line of credit- This is an option that allows the borrower to use their house’s equity as collateral to secure a loan.
Boat loan- a boat loan is used to buy a boat
Unsecured loans – This is a type of loan where the lender does not require collateral from the borrower. Lenders give loans based on the borrower’s creditworthiness and word instead of security. For this reason, loans without collateral are risker for the lender. Without strong credit, an unsecured loan is unlikely to be granted. With unsecured loans, you can expect higher interest rates. When you take an unsecured loan, you aren’t placing any collateral at risk, but you are still potentially taking on additional debt.
What happens if a borrower fails to repay an unsecured loan? Though unsecured loans don’t incur harm such as losing your collateral but failure to repay an unsecured loan means that the borrower’s credit will suffer. Late payments stay on the borrower’s credit report and this affects their credit history. if a lender pursues legal proceedings against the borrower, the action would show up on the borrower’s credit report.
Examples of unsecured loans
- Personal loans
- Credit cards
- Student loans.
The simple difference between secured and unsecured loans
Secured loans are easy to get compared to unsecured loans, if a borrower gets approval for a secured loan, they can borrow more money but their property is at risk. Taking out an unsecured loan does not jeopardize the borrower’s property; however, they will pay more interest.
Other types of loans include; term loan and revolving loan
Term loan – This type of loan has a consistent interest rate and this helps you forecast your debt and avoid unexpected debt fluctuations. It also has a fixed repayment term, fixed repayment schedule, and fixed loan amount. Depending on the loan amount required, the borrower’s eligibility, and the loan term, collateral may or may not be required.
Revolving loan – This type of loan allows a borrower to take money out, use it to finance their business, repay it, and then take it out again when they need it. It’s only one of the many flexible financing options available in today’s alternative finance market.
Here are a few things you should know before taking a loan
- Apply for the right loan- When applying for a loan, avoid applying for more than what you can repay, consider your monthly and annual budgets when determining the type of loan to apply for. Then, apply for a loan amount that you are confident you can repay.
- Interest Charges- When you take a loan, you must repay the principal amount you borrowed plus interest, which is typically spread over the term of the loan. You can obtain loans for the same principal amount from multiple lenders, but if the interest rate or term of the loan varies, the total interest paid will vary.
- Loan charges- Depending on the lender, a borrower might need to pay fees such as;
- Application charges: Covers the cost of the loan approval process.
- Late charges: The amount charged by the lender for late payments.
- Processing charges: this fee covers the costs associated with loan administration.
- Annual charges: A one-time fee payable to the lender on an annual basis (prevalent for credit cards)
- Prepayment charges: The cost of repaying a loan early (most frequently associated with home and auto loans).
- Penalties- One thing to keep in mind before taking a loan is the penalty charges or consequences for not repaying the loan by the due date. Different lenders may impose different penalties on borrowers for failing to repay on time and these penalties can harm the borrower.
- Pay off-plan- This is a critical factor to consider before taking a loan; if you take out a loan, you will undoubtedly have to repay. Ascertain that you have a repayment plan in place, whether weekly, fortnightly, monthly, or yearly. Having a repayment strategy in place will assist you in making the best choice regarding the type of loan you wish to obtain.