Different Types of Loans Explained

A loan is an all encompassing term that refers to any type of money you have borrowed in some form. Although we often think of a typical loan from the bank or a credit card, there are many different kinds of loan, each with their own pros and cons. The one you choose will be dependent on your individual needs.

Credit Cards

Perhaps the most common form of loan is the trusty plastic known as a credit card. It has facilitated cashless payments across the world and allows you to borrow on a recurring basis, so long as you stay within your set credit limit. These are ideal for month to month expenditures and larger one off purchases. You are charged an interest rate on the outstanding balance on a monthly basis (typically between 9 and 19%) and you are only required to repay a small minimum on that outstanding balance each month. If you pay off the balance in full before the next due date, you are not usually charged any interest.

Credit cards are extremely versatile, allowing the user to withdraw cash from an ATM and pay for goods and services almost everywhere online or offline. It is up to you how much of your total limit you use at any given time.

Common card issuers include Mastercard, Visa, American Express, and Discover.

Personal Loans

A personal loan is the type of loan most individuals apply for at the bank or other large lender for their own private purposes (as opposed to starting a business or taking out a mortgage). They are usually unsecured (no form of collateral like a home or other valuable item to back it up) and are taken out over a medium to long term basis. This means the principal amount and any interest is repaid in installments over several months. It is usually applied for by borrowers who want relatively fast access to credit and have determined a credit card isn’t suitable. Most people with a fair credit score and a regular source of income will have access to some form of personal loan product. Most personal loans are for at least a few hundred dollars and regularly go in to the thousands. The longer the term, the more that can be realistically borrowed, however the higher the overall amount of interest that you will pay.

Payday Loans

A payday loan is a unique concept within the loan industry that does not typically come with any installments. The borrower is required to pay the full amount back with any fees and interest, in one lump sum, only a short time after it is issued. This is usually about two weeks. The reasoning behind this is that these loans are designed to help tide you over until your next pay check arrives. They are commonly used by those who have gone over their budget that month or were faced with some kind of unforeseen expense or emergency, and don’t have other access to credit or savings. Payday lenders tend to be more lenient with approving loans than banks or large lenders, but they also tend to deal with smaller sums of money.

Overdrafts

An overdraft is a product offered by banks that allows the customer to go overdrawn on their checking account, effectively creating a line of credit. The customer is not penalized or charged for going overdrawn like normal, as long as they stay within the overdraft limit. They may be charged interest on the outstanding balance on a monthly basis like a credit card, or pay a regular fee for using the overdraft. An overdraft is the perfect way to protect yourself from unforeseen withdrawals or to use for short term borrowing.

If you had an overdraft of $200 and only have $100 in your account, you could charge $300 to your account because of the overdraft.

Mortgages

Mortgages are a secured loan exclusively used to fund the purchase of real estate. They are therefore for large sums of money and span many years in repayments. Because of the sums involved they are also one of the most stringent, requiring the borrower to divulge lots of info about their financial situation, history and even personal life. Like all loans mortgages come with an interest rate (this may be fixed or variable), which is usually paid off first before you begin paying down the principal itself. Mortgages are one of the only ways most people are able to purchase a home if they cannot afford one outright. Over time you may be able to take out a second loan on the equity from the mortgage, meaning if you’ve paid off x amount, that amount can be re-borrowed.

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