Loans

Loans have become part and parcel of our lives, and we take loans for various reasons, sometimes unknowingly as well. For example, if you have just paid your grocery bills, or ordered anything online, with your credit card, you have actually taken a loan from the card issuing bank. Our reasons for taking loans are varied and various. It may be for a new home, to go for higher education, to improve our homes, to garner capital for our businesses, or even to pay off other existing loans. Multiple options and multiple types of loans are available for a particular need. Moreover the cost of loans, or the interest rate, may also vary from provider to provider. Hence, before you take a loan, it is imperative that you know the different types of loans that are available to you and the types of loans that are best suited to you, both in the long run and in the short run. Go through our guide below, and know about the different types of loans, before you apply for one, and save money.

What Loan Should I Go For?

Choosing the Right Loan: A Guide to Aligning Your Needs with the Perfect Option

The loan landscape offers a multitude of options, each catering to specific needs. Selecting the right loan hinges on understanding your financial situation and aligning it with the loan's features. Here's a roadmap to guide you towards the perfect loan:

1. Identify Your Loan Purpose:
   • Debt Consolidation: Looking to simplify and potentially reduce the interest burden on existing debts? Explore debt consolidation loans.
   • Major Purchase: Financing a car, home improvement, or another significant expense? Auto loans, home equity loans/lines of credit, or personal loans could be suitable options.
   • Education: Need funding for higher education? Student loans are specifically designed for educational expenses.
   • Business Needs: Expanding your business? Small business loans can provide the necessary capital.
2. Consider the Loan Amount:
   • Loan amounts vary depending on the loan type.
   • Assess your needs and borrowing capacity to determine the appropriate loan amount.
3. Evaluate Loan Features:
   • Interest Rate: This significantly impacts your overall loan cost. Opt for the lowest possible interest rate you qualify for.
   • Loan Term (Repayment Period): A shorter term translates to higher monthly payments but lower total interest. A longer term offers lower monthly payments but potentially higher total interest costs. Choose a term that aligns with your budget and repayment goals.
   • Fees: Be mindful of origination fees, prepayment penalties, and other associated charges. Factor them into your overall loan cost comparison.
   • Prepayment Flexibility: Consider if the loan allows you to make additional payments without penalty. This can help you save on interest and pay off the loan faster.
4. Match Your Creditworthiness to the Loan:
   • Loan products have credit score requirements. Your credit score significantly affects the interest rate you qualify for. Generally, higher credit scores unlock lower interest rates.
5. Explore Loan Options:
   • Banks, credit unions, and online lenders all offer loans with varying terms and rates.
   • Shop around and compare loan offers from multiple lenders to secure the most favorable terms.

Common Loan Types and When They Shine

• Secured Loans: Require collateral (like a car or house) to qualify. They often offer lower interest rates due to the reduced risk for the lender. Examples include home equity loans/lines of credit and auto loans.
• Unsecured Loans: Don't require collateral but typically come with higher interest rates. Examples include personal loans and student loans.
• Fixed-Rate Loans: Offer a consistent interest rate throughout the loan term. Suitable if you prefer predictable monthly payments.
• Variable-Rate Loans: The interest rate can fluctuate with market conditions. Can be risky but may offer lower initial rates.

Remember: Don't rush into the first loan offer you receive. By carefully assessing your needs, comparing loan options, and understanding the various features, you can make an informed decision and secure the loan that best aligns with your financial situation.

Understanding Loans:

Loans classified by nature

Loans may be secured or unsecured. A secured loan is a loan, that is fully, or partially backed by a physical asset. For example, you car loan is backed by the car you purchased with the loan, your house loan is backed by the house, and you may also take a personal loan, pledging some asset that you may have. The secured nature of the loan reduces the risk of the bank, which reduces the interest rates.

An unsecured loan, on the other hand, has no underlying asset to it, and there is no collateral security with the loan. A typical example is your credit card limit, or a personal loan without any collateral security. Because the risk is higher for the bank, these loans generally have a higher rate of interest.

Loans Classified by mode of repayment

Loans may be repaid by various modes, but two modes are the more popular ones, as given below:

Repayment with fixed EMIs: A term loan, or a housing loan can be repaid with equated monthly instalment, over a period of time. These loans are also called instalment loans.

Revolving Credit Loans: Revolving credit have a fixed borrowing but no fixed repayment amount every month. Your credit card is a typical example. You can spend (or borrow) upto the limit offered, but can choose to pay the minimum amount due, something more than the minimum amount due, or the entire amount at one go. A similar case is with overdraft limits extended to businesses. Whatever loan amount you do not pay this month, will revolve over to the next.

Fixed Rate Loans: These loans will carry a pre-decided, fixed rate of interest, in the entire tenure of the loan, no matter what the interest fluctuations are. If interest rates go down, banks benefit, while if they go up, you benefit. Generally speaking, these loan's rate of interest is slightly higher than the market floating rate of interest, as they shield you from the ups and downs of the interest rate market.

Variable rate loans: As you have already guessed, these loans are just opposite to fixed rate loans, and they offer you a floating rate of interest, directly tied with the market rates. You rate of interest may be revised every quarter, half yearly, yearly, or even monthly. Depends on the lending institution and your agreement with them.

The most common loan types, prevalent in the US market:

It's all a game of your credit score and credit history

You must have witnessed that some people get loans easier, and at better rates, than others. Well, apart from the documentation aspect, there is another major aspect. The credit scores. Check out our guide on credit scores, how to manage your credit scores and increase them, and how to maintain a good credit score.

Loan Calculators

Wondering what will be your loan repayment amount, the instalments and the EMIs, based on loan amount, or varying interest rates? Well, we have a variety of financial loan calculators here, which you can use, by inputting different values, and know what your financial burden will be like, for any loan you take. Click here for our loan calculators.

Loan type that you should strictly avoid: Payday Loans

By all means, avoid pay day loans. If you have already taken one, then take a debt consolidation loan or even a personal loan, and pay off your payday loan. They are supposed to be paid off in full, with very high rate of interest, by your next payday. High interest rate is charged as no credit score check or credit repayments records are checked. One renews the loan on non repayment at the next payday, paying the interest part only, and the vicious cycle continues. So immediately clear off all your payday loans, before you embark on a solid and prosperous financial journey.

Would you like to know which loan types have lower interest rates?

• Please note that even the same type of loan (say personal loan), for the same person can have different rate of interest, depending on the credit provider or the bank. Hence it is imperative that you check your options with a few banks, before you take a major loan. Generally speaking though, higher your credit score, the lower rate of interest offer you will receive, rates will be higher for unsecured loans, and for short term loans.
• Traditionally, home loans, or mortgage loans have offered the best rate of interest, owing to the solid security as collateral, long period of repayment, and loan taker's intention of positive loan servicing record in the sector. It makes good sense to take house improvement loans along with mortgage loans, as you get extra loan money in the same lower rate of interest. As of September 30, 2021, the average mortgage rate on a 30-year fixed-rate mortgage was 3.01%.
• Student loans, due to their nature of building of country's future, also have low rate of interest. Federal student loans first disbursed on or after July 1, 2021, and before July 1, 2022, range from 3.73% to 6.28%; While their counterpart, the private student loan charges range from 1.04% to 12.99%.
• Want to avail a loan for your motorcycle or your car? A 48-month auto loan, the average interest rate was 5.28% as of May 2021.
• Personal loans, being mostly of being unsecured loans in nature, have higher interest rates. APR (average) on a two-year personal loan was 9.58% as of May 2021.
• Credit cards however, owing to their convenience, come our clear winners in this sector. It is also why squaring off the entire credit card balance is so very important for your financial discipline, and to save you from a credit trap. Credit card APR was 16.3%, on n average, as of May 2021.