Credit cards in a wallet.

The Basic Types of Loans

Loans can seem complicated but when you break everything down to the most simple element, they are really not that complex. On this page, you will find a very simplified description of the kind of loans that you might face in your life.

Some Loans Are Secured

You will run into both secured loans and unsecured loans.

Secured Loans

Secured loans are, just like the name implies, secured by property. The property could be what is purchased with the loan or it could be other property that you put up to guarantee the loan.

The benefit to a secured loan is that the interest will generally be lower than with an unsecured loan. This is because the lender has more of a guarantee that they will get their money back.

The downside to a secured loan is that the lender has the right to take your property if you default. If you do so, they would seize the property and sell it. They would then pay off the loan and send you the difference. In addition, you will be prevented from selling your property until the loan is paid back in full.

A common example of a secured loan is an auto loan. With an auto loan, the lender is listed as a lien holder on the vehicle. You can not sell an auto with a lien unless you pay off the original loan first.

Unsecured Loans

Unsecured loans are not backed by any property. With this type of loan, your lender is depending on your credit exclusively to determine the risk of lending you money. If you default, they can not seize any of your property. Because there is nothing backing these loans, interest is normally higher than that of a secured loan.

If you were to default on an unsecured loan, the lender does have ways to get their money back but it may take them longer. The first thing that they would do is report the non payment to the credit bureaus. This would likely cause your credit score to plummet. In addition, they can sue you for the money owed and may be able to secure a judgement against you.

The most common example of an unsecured loan is a credit card. Lenders give you a credit card with a set limit that you can use on whatever you like. They do not have any claim on your purchases. Other unsecured loans include payday loans and student loans.

Some Loan Rates Can Change

There are loans out there where the interest remains constant and some can go up or down over the course of the loan.

Fixed Rate Loans

With a fixed rate loan, the interest rate that you pay will never change over the entire course of the loan. This is great because you will know exactly how much your payment will be until the day that the loan is paid in full.

Auto loans are a good example of a fixed rate personal loan because the rate will never change. Most home loans these days are also fixed rate but they can also be adjustable. If you have a fixed rate home loan, the lender will give you an interest rate at the beginning of the loan and it will never change. This means that your payment, more or less, will never change.

Variable Rate Loans

With this type of loan, the rate can change over time. There is normally a set period where the interest will stay the same and then it is updated at set intervals. Adjustable rate loans can be risky but there may be times when you would want to consider one.

If you are taking out a home loan and only plan on being in it for a few years, an adjustable rate may be in your best interest. Rates are generally cheaper on an adjustable rate mortgage, initially at least. Additionally, if you expect interest rates to drop over time, you might benefit from an ARM.

Some Loans Never Come To An End

The last two loan types I will talk about are closed and open ended loans.

Closed End Loans

These loans have a date set where they will end. It is a loan with a set amount of debt that can not be added to. For example, you take out a car loan in the amount of $20,000 and then make payments of $400 a month. You make the payments until the loan is paid off and then the loan is closed and marked paid in full on your credit report.

Open End Loans

With this type of loan, you can borrow against a set credit limit. If you have a credit card, you are familiar with this type of loan. You can charge the card up if you need money today and then pay it off when you get the statement. You can repeatedly do this as the credit line is not designed to end. This type of loan only ends if you or the creditor decide to close it.

Posted by
James Car

James Car is a finance, loan and budget expert based in the United States. After attending Brookhaven college, he went on to become a successful entrepreneur. He now enjoys writing articles that help people save and make the most of their money.