When you set out to borrow, you often come across terms like unsecured loans, revolving loans, adjustable rate loans, etc. While these terms are more or less self-explanatory, it is still useful to be clear on their exact meanings and what they imply before you finalize a loan contract.
Unsecured versus secured loans
As the name implies, a secured loan is one where you offer some kind of collateral against the loan. The agreement is that if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged.
In most cases, this asset would be what the lender has financed. For example, when you take a home loan, you offer the home as collateral.
There may also be cases where you may need to offer additional collateral over and above the asset that is being financed. This happens, for example, when the lender is financing close to 100% of an asset that is prone to rapid reduction in market value. In such cases, the lender may insist on your putting up another asset so as to provide a reasonable margin of protection in case of default.
Unsecured loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors.
In cases where there's a choice available to the customer to take either a secured or an unsecured loan, the former may be offered at a somewhat lower rate. That is, assuming every other factor remains equal. This is because of the lower risk involved to the lender, who has recourse to a specific asset in case you default. However, this situation is comparatively rare in consumer financing, although it is more common in financing businesses.
Installment versus revolving loans
A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan.
You pay interest only on the amount you borrow for the time you borrow it. Sometimes, banks may charge a commitment fee for making a revolving line of credit available to you. This fee is usually charged on the average unutilized amount of your limit.
You can also re-borrow the amount you have repaid. In effect, you have a loan that's always available to you on demand.
Unlike revolving loans, installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid.
Adjustable rate versus fixed rate loans
A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you (the borrower) is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan.
In practice, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Bear in mind that your current lender may charge a pre-payment fee if you choose to repay before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a switch.
An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime (or best) borrowers. The advantage of an adjustable rate (or floating rate) loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable.
As a borrower, if you hold the view that interest rates are going to decline, it is best to opt for an adjustable rate loan. But arriving at the correct view consistently is easier said than done. Predicting interest rates is a game where even professional market participants and institutions frequently go wrong.
If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. After all, you can refinance it should the interest rates fall significantly.
Keeping these basic facts in mind should help you make more informed borrowing decisions.
About the Author
Prakash Menon is a financial expert and writer specializing in managing personal debt and providing wealth building solutions. He has written on payday loans, personal debt management and other related topics.
Free Auto Loan TipsThe following tips should help increase your... Read More
The revolution that has affected everyone's financing technique is online... Read More
Unemployment is generally supplemented with several other vices like poverty... Read More
Online payday loans can get you fast cash through a... Read More
It has always been an issue for home buyers to... Read More
Daughter's marriage or her studies? Son's Ambition? Want a House... Read More
Bankruptcy has a stigma attached to it that is hard... Read More
Financial statements, salaries, income proof, documents, paycheck, W-2 forms, 1099's... Read More
If you considering using a Cash Advance Payday Loan service... Read More
To find the quickest payday loans, you need to look... Read More
Here is a useful guide to Personal loans. What is... Read More
Before entering college, you may find yourself pondering exactly how... Read More
With less than a week before she was to receive... Read More
Payday loans offer a fast and easy solution to financial... Read More
Title loans have the same features as a secured loan,... Read More
If you're searching for an adverse credit homeowner loan, you... Read More
Outlined below is a guide to unsecured loans. It will... Read More
Working under the most prestigious service of the country ?... Read More
Some of the many benefits of a Home Improvement Loan... Read More
On average, homeowner households earn 95% more than renting households... Read More
For the individual in need of cheap loans UK, it... Read More
No one can say for certain where the history of... Read More
A payday loan or cash advance can be a life... Read More
In his 1968 seminal novel, 2001: A Space Odyssey, Arthur... Read More
A Bad Credit loan is a personal loan for people... Read More
Even it you have no credit history, you can still... Read More
If you find yourself in need of poor credit loans,... Read More
A no income verification home equity loan is a second... Read More
Listed below are some of the many reasons why you... Read More
Watching more and more people fall in the trap laid... Read More
Big financial goals, no security to supply - it is... Read More
Regardless of your trading style; day trading, swing trading, or... Read More
As the name implies, bridge loans fulfill a vital need... Read More
Here is a useful guide to getting a bad credit... Read More
A secured loan is any loan that is secured on... Read More
What is man's greatest invention?Some of the latest gizmos would... Read More
In this second installment, we will further examine what kinds... Read More
There are lots of ways to get additional capital to... Read More
Here are some useful secured loans tips. Secured loans enable... Read More
Are you wondering why choose a secured loan? A secured... Read More
Watching more and more people fall in the trap laid... Read More
For those in the market for a loan UK ,... Read More
Trying to get a bad credit personal loan can be... Read More
Here are some useful tips on Personal loans. You can... Read More
For those individuals who are looking for fast and inexpensive... Read More
Trying to find good UK secured homeowner loans might seem... Read More
Homeowner loans UK are a very versatile type of personal... Read More
For the individual in need of cheap loans UK, it... Read More
A Home loan is the generic term for a loan.... Read More
Getting a loan to buy your new car is, you... Read More
No matter what your credit history is the simple fact... Read More
One of the most enduring myths of loan industry is... Read More
A Personal secured loan can offer many benefits, some of... Read More
Do you need fast cash to get your car fixed... Read More
Listed below are some of the many reasons why you... Read More
Whether your payday arrives every Friday or every other Friday,... Read More
The secured loan is favoured by many UK residents seeking... Read More
In his 1968 seminal novel, 2001: A Space Odyssey, Arthur... Read More
Can I Ask my Family for a Loan to Pay... Read More
The conception of wedding has changed over the years. Its... Read More
Borrowing money has become more and more popular in the... Read More
If you have poor credit or a recent bankruptcy, you... Read More
Car loans are a tempting way to purchase a new... Read More
If you're in a crunch for money, either because of... Read More
It is quite common for someone, who is having trouble... Read More
Comparing payday loan companies online saves you time and money.... Read More
Loan |