It doesn’t matter if you’re getting ready for college, an emerging entrepreneur, or just someone looking to purchase a car or home, getting a loan is confusing! Before you head to the bank, here are some basic lending terms everyone should know!
Cost of the Loan
Those taking out a loan for the first time should understand that all of them have additional fees; this is how the lender makes money on the loan. The Annual Percentage Rate (APR) is the cost of the loan, expressed as an annual interest rate. It also covers any documentation and organization fees. When considering APRs, remember, there are two types:
- Fixed: As you might have guessed, fixed APRs stay the say the same for the length of the loan, regardless of what market interest rates do.
- Variable: On the other hand, with variable APRs, the interest charged on the outstanding balance of the loan varies, depending on what market interest rates do.
While the distinction between the two is simple, which one is best will depend on the amount borrowed, length of the loan, and the financial forecast.
Secured vs. Unsecured Loans
Just like there are different types of APRs, there are different types of loans: secured and unsecured.
- Secured: With secured loans, the borrower offers up some form of collateral, if they don’t pay the money back. For instance, with home or car loans, the insurance is often the car or house purchased with the loan. Secured loans usually come with lower APRs, because secured loans give lenders a guarantee.
- Unsecured: These are the opposite of secured loans, loans that do not require collateral. As a result, the lender has no way to guarantee that the borrower pays the money back. So, unsecured loans often come with much higher interest rates.
Occasionally, a lender might ask a borrower to sign a personal guarantee with an unsecured loan, allowing the lender to take them to court if the borrower does not payback. This will often result in a lower APR for an unsecured loan.
The Nitty-Gritty Details
Sometimes, details become lost in the nitty-gritty. So, make sure not to mix up tough lending terms, like the “term of the loan” and a “term loan.”
- Term of the Loan: This is the time that the borrower has to pay the money back. On average, personal loans take anywhere from three to seven years to pay back, while home loans can last for more than 30 years. However, this will vary by loan, so remember to note this down. Of course, it’s possible to pay the loan back before the term ends. And, usually, longer terms mean higher APRs, as it’ll take longer for the loaner to get their money back.
- Term Loan: Term loans are specific, business loans, that banks often give to established small businesses for one-time purchases of equipment, real estate, or the like.
Hopefully, these terms help navigate the tricky waters of the loan world. Of course, even if you understand every loan term inside and out, you should still talk to your finical advisor before you apply!