Loans can be a tricky thing, but when you understand them, you can make more educated financial decisions. It’s not easy to get by in today’s world without borrowing money. Not many people have $250,000 to pay cash for a new home. For that matter, how many are able to withdrawal $20,000 for a new car?
If you want to buy a big-ticket item today, the odds are good that you’ll be taking out a loan of some sort. If financial concepts are hard to understand and you are not sure about the difference between interest rates, title insurance and the APR, don’t worry. These are not as difficult to understand as you may think.
It does not take an advanced finance degree to learn the basics of the various loan types you’re apt to encounter in your lifetime. The following is a quick course in how these loans work, and which ones offer better deals for you.
Secured loans generally offer lower interest rates than other types of loans. This is because they offer collateral to lenders. The lenders take less risk because the loan purchased something of value that can be exchanged for the loan. Collateral can be anything from a house, in the case of mortgage loans, to a new car for an auto loan.
Collateral works like this: If you default on your loan, your lender can take your house, car or item of value that was purchased with the loan.
Mortgage loans are some of the most popular secured loans. The vast majority of homebuyers take mortgage loans to finance the purchase of their new residence. Interest rates on mortgage loans vary depending on the economy, personal credit score, debt-to-income ratio and employment history. In mid-2010, though, the average interest rate on a 30-year, fixed-rate $200,000 mortgage loan stood at 5 percent. That was an extremely low rate for such a mortgage loan. Current mortgage rates will fluctuate according to a number of factors.
Another popular type of secured loan is the auto loan. The interest rates on these loans vary as well. In 2010, though, the average $20,000 auto loan came with an interest rate of 7 percent. For preferred borrowers, these rates can be much lower. Like mortgage rates, auto loan rates fluctuate considerably as well.
Home Equity Loans
Home equity loans are another type of secured loan and are similar to mortgage loansThis type of loan is based on the amount of equity (value above debt on the home) you have built up in your residence. For example, a $20,000 home equity loan generally comes with an interest rate of 9 percent, lower for good credit and higher for people with bad credit.
Unsecured loans, loans without collateral, tend to come with higher interest rates. That’s because lenders are taking on more risk when they loan their money.
A $5,000 personal loan, for instance, will typically come with an interest rate anywhere between 9% to 18%, depending on the borrower and the bank. Credit cards are a type of unsecured loan as well. This is the most popular and used type. As of 2010, the average interest rate on a credit card stood at 16.78 percent.
The worst type of unsecured loan that you can take out? Based purely on the interest you pay, it’d have to be an installment loan. These short-term loans – usually for no more than $500 – can come with interest rates as high as 400 percent. It’s little surprise, then that so many state legislatures have introduced legislation to regulate the way installment loan lenders operate.