We all have our aspirations of dream schools, businesses, houses, and vacations, and these dreams may seem far away at times, especially if money is tight. However, what if there was a way to make your dreams a reality in the near future? Many Americans take out various types of loans in order to pay for a number of things, such as their children’s education, a new car, or their wedding. You, too, can take out a loan to reach your goals in life quicker. However, to do so in a smart way with the least amount of debt is hard to do, especially if you’re not very familiar with the types of loans there are available. Getting educated on the pros and cons of the different types of loans there are can help prevent you from falling victim to the common catastrophe of crippling debt.
Types of Loans
When you take out a loan, you are borrowing a lump sum of money from a lender. The lender stands to benefit from this by charging interest on the amount you’ve borrowed. The amount of interest charged depends mainly on your credit history and current income. There are several types of loans with different terms and conditions, and you should familiarize yourself with these differences before you start applying for loans.
As the name suggests, open-ended loans are loans that you can take out over and over again over time. These loans are preapproved and a certain limit is determined before an agreement is drawn. The most common type of open-ended loans that people take out is credit cards. The other most common type of open-ended loan taken out is lines of credit. With the credit limit set by the lender, this is the maximum amount of money you can borrow at any given time. Naturally, this means you can borrow as little as you want as well. It’s in your best interest to borrow as little as you can so you pay as little interest as you can. Plus, it’ll make repaying the loan easier. With open-ended loans, your available credit increases and decreases depending on the amount of repayments you make. So long as you adhere to the terms set out, you can use the same credit for as long as you want.
Closed-ended loans also are what exactly they sound like — they are opposite from an open-ended loan in that they are a one-time loan that you cannot borrow on once you’ve repaid the full amount borrowed. This means that while you’re making payments on the loan, your available credit does not increase. Instead, it just gets closer and closer to $0 for your available credit, and when it reaches that amount, you’re done with your closed-ended loan. If you need to borrow more money, you then have to apply for another loan. The credit limit is also set by the lender before you sign an agreement. The most common types of closed-ended loans that people take out are student loans, auto loans, and mortgage loans.
A secured loan is called so because you only get one when you put down collateral, such as a car or property. This provides security for the lender since if you’re unable to pay back the loan and default on it, they can take the asset you put down for collateral and make that the payment for the rest of the loan you couldn’t pay off. Because of this security, typically, interest rates are lower for secured loans than they are for unsecured loans. However, before you put down collateral for your secured loan, you may need to get it appraised first so that its value is legally confirmed. After appraisal, the lender you’re interested in may only offer you a secured loan that is the maximum worth of your collateral. Others may offer you higher amounts for your loan, so be sure to shop around. A common type of secured loan that people apply for is the title loan.
The opposite of secured loans, unsecured loans don’t require any collateral to be put down in order for you to obtain one. As mentioned above, this makes it have higher interest rates. It may also be very hard for you to get, since lenders may be unsure of your ability to repay the loan without collateral as security. Instead of basing the loan on collateral, lenders look at your credit score instead. Should you be unable to pay back the full amount of the unsecured loan, the lender has to rely on themselves to get that money back. They may result to measures such as sending debt collectors after you or filing a lawsuit against you.
A conventional loan is also known as a mortgage loan. A conventional loan is a mortgage loan that is not associated with any government agencies. This includes the Federal Housing Administration (FHA), Rural Housing Service (RHS), Veterans Administration (VA), and Farmers Home Administration (FmHA). The terms are usually fixed in its terms and rates. There are two types of conventional loans: conforming and non-conforming.
Conforming Conventional Loans
Conforming conventional loans are the ones that follow the guidelines that are set forth by Fannie Mae and Freddie Mac. The general guidelines include a maximum loan size of $417,000, although there are such things as super-conforming loans, which have higher limits. You must have a debt-to-income ratio (DTI) that follows the guidelines, and when you borrow a conforming conventional loan, it must be properly documented. Conforming conventional loans usually have lower interest rates than non-conforming loans do.
Non-Conforming Conventional Loans
People usually turn to non-conforming conventional loans because they don’t qualify for conforming loans. As the name suggests, this type of loan does not meet the guidelines set forth by Fannie Mae and Freddie Mac. Because they don’t follow specific guidelines, non-conforming conventional loans usually have higher interest rates than conforming conventional loans do. In addition, they may also have upfront fees and certain insurance requirements.
The most common type of non-conforming conventional loan taken out is the jumbo loan. Jumbo loans don’t follow the guidelines needed to be a conforming conventional loan because the amounts are too high. They typically have a higher interest rate attached to them because they are harder to sell on the secondary market. By hiking the interest rate, lenders protect themselves should they not be able to resell these loans.
Types of Loans to Avoid
When you’re short on cash and desperate for easy access to money, it may be tempting to take the first loan you can see. However, lenders count on people’s desperation for quick money and oftentimes prey on those who are in serious need for cash. Here we discuss the various types of loans you shouldn’t go for, even if you need it to keep the electricity on in your home.
At first glance, it may seem like a good idea to take out a payday loan. It is a short-term loan where your next paycheck is used as the guarantee for your loan. All you have to do to get a loan is to show proof of income. However, this kind of quick cash comes at a high price — a high APR, to be exact. This means the amount you have to pay back to your lender is extremely high compared to what you borrowed. Chances are, you’re not in a financially good place if you had to take out a payday loan in the first place, and with the high amount you have to pay back for the payday loan, you’d most likely get caught in a large web of debt since you’d be caught in a vicious cycle of taking out payday loans repeatedly to cover your previous payday loans. Instead of squaring away your financial troubles, you’d be multiplying them. This short-term solution to your money problems can actually turn into a nightmare, so avoid payday loans at all costs.
Advance Fee Loans
Although it may have the word “loan” in it, you actually never see the money when you apply for an advance fee loan. This type of loan is actually a scam. These fake lenders sweet talk you to get you to pay an upfront fee before you can obtain a loan from them. Once you’ve been convinced to send the money and the lender has received it, this is the last you’ll see or hear from them. They’ll take your money and never actually loan you any money. So not only are you out of your own money, but you won’t have additional money to make whatever purchase you wanted to make or pay whatever bill you were planning to pay.
Bad Credit Car Loans
Most people don’t have the upfront cash to pay for a brand new car, so automobile loans are often used to finance the purchase of a vehicle. As expected, loans with better interest rates are offered to customers who have better credit scores. People with bad credit scores find themselves in a bind when they find that they can’t even qualify for the loans they want or need. Some lenders take advantage of the bad credit score market and offer automobile loans to people with bad credit, but with a catch — high interest rates. In general, if the interest rate of the loan you’re looking at is in the double digits and you have to pay off your car for longer than four or five years, you shouldn’t take that car loan.
Fixed Rate vs. Variable Rate Loans
When you look around for loans, you may notice the terms “fixed rate” and “variable rate” floating around quite a bit. But what exactly do they mean, and which one is better for you?
Fixed Rate Loan
A fixed rate loan is a loan that has a set interest rate for the entire duration of the loan period. This gives you a feel of certainty since you know exactly how much interest you’ll be paying for the entire time. You’ll also know exactly how much you’re making in payments every month. Some examples of fixed rate loans include auto loans, student loans, and mortgages.
Variable Rate Loan
A variable rate loan (also known as a floating rate loan) doesn’t have a set interest rate for the entire duration of the loan period and instead, fluctuates depending on the market interest rates. It may be riskier signing up for a variable rate loan as opposed to a fixed rate loan since you can either come out for better or for worse with a variable rate loan. Generally, variable rate loans have a lower starting interest rate than fixed rate loans, but that interest rate can change and increase during the life of the loan. However, there is a thing called a variable loan cap, which ensures a maximum limit on the interest rate you’re charged, even if the index interest rate on the market is higher than the cap. A downside to choosing a variable rate loan is since the interest rate can change every month, the amount you pay monthly won’t be fixed. This can be stressful to plan for if your finances are a bit tight and you need to account for every penny that goes out of your bank every month.
What’s the Right Type for You?
There is no wrong or right choice when it comes to fixed or variable rate loans. However, depending on your personality, there may be one type of loan that is more suited for you. For example, if you’re a very structured person and doesn’t like surprises, a fixed rate loan may be better for you since the monthly payment amounts are consistent. This type of loan may also be the better choice for you if you prefer to pay off loans over a longer amount of time.
However, if you’re a person that likes to get a little risky and tries to maximize on potential savings, a variable rate may be more suited for you. If you have enough finances to make allowances for higher monthly payments at times, and you want to pay off your loan in 10 years or shorter, you may consider choosing a variable rate loan over a fixed rate loan.
How to Get a Loan
Preparation for Applying for a Loan
First, you need to get a current credit score. You can request one for free from the three major credit bureaus. Then, do your research on what loans you’re interested in and if you qualify for them based on your current credit score. If that information isn’t listed on the lender’s website, you can either visit them in person or give them a call to ask what the minimum credit score is to qualify for their loans. It is important to whittle down the list of potential loans since every time you apply for a loan, your credit score goes down a little. Request loans quotes online so you can get a good idea of the interest rates and terms before you apply for them.
You should then gather all the important information about your financial situation since all loan applications ask for information such as your social security number, monthly house payments, your employment status, length of employment, income generated, etc. Having all these pieces of information at the ready can help make the application process smoother and more efficient.
Applying for Your Loan
Typically, you can request loans by walking into an institution and inquiring about them. Their representatives will go through all loans applicable to you and your personal situation and then hand you forms to fill out with your personal information. Once you’ve returned the forms to them, the representatives will then send them to the appropriate departments for review and you’ll hear back after a week or so about if you qualify for the loans you’re interested in.
Nowadays, you can log on and request loans online. This is a much simpler and quicker task than inquiring at physical institutions since you won’t have to waste gas money or your time going from place to place to speak to representatives and to gather different forms. From the comfort of your home, you can access forms from multiple lenders and quickly fill out your information. This can be made even quicker if your browser has an autofill option. You’ll also hear back from lenders much quicker by applying online. In fact, you can get a response within minutes regarding whether or not you’ve qualified for their loans. You can then complete the loan application process from home without having to visit the physical location of the lender’s office. Another perk of applying for loans online is that many don’t impact your credit score when you apply. This opens up more opportunities since you can apply to those loans freely without fear of your credit score dropping.