Types of Loans
Anyone who is in debt can take out a loan to help rectify their financial problems. It presents you with an opportunity to start a clean slate and to initiate a new mindset when it comes to organizing your finances. A loan will help you achieve this by allowing you to repay your debt in a structured and disciplined way, over a period that suits your current financial position.
A loan is essentially a sum of money provided to you by a lender that comes with a specified repayment period and a calculated rate of interest. The appropriate type of loan is decided upon depending on the particular needs of the borrower.
Loans can be taken out for personal or business uses, ranging from a personal purchase to a mortgage for a home or office building. Every loan differs in terms of its conditions, which will be agreed upon contractually between the lender and the borrower. The main types of loans are as follows:
Interest-Only
With this kind of loan you only pay interest for a limited number of years, which means that you initially have significantly lower monthly payments. All types of loans – including a fixed-rate and adjustable rate loan – can include an interest-only payment option.
Lenders must be aware of the risk involved in this kind of scheme as your interest-only period will eventually expire. This can raise your monthly payments considerably because you will have to repay the full balance of your loan in a shorter period of time.
Remember that although you are paying off the interest on the loan, the overall mortgage balance doesn’t decrease. This option is usually better suited to people making good money as it will be difficult to make increasingly big payments over time if you are still earning the same amount.
Fixed-Rate
In this case the interest rate attached to the loan will remain the same throughout the entire term, giving you peace of mind that your payments will never go up. On the downside, you will have to pay a slightly higher interest rate because of the fact that your interest rate is fixed.
Your fixed monthly payment is the amount that you pay each month to ensure that the full amount is paid off, along with the interest, by the end of the period agreed upon. The term of repayment ranges between 15 and 40 years, and it is generally a rule that the longer your repayment period, the higher the rate of interest that you will be charged.
Adjustable Rate Mortgage (ARM)
ARMs are popular because they offer the borrower a lower interest rate to begin with, which then increases or decreases every 6 to 12 months. The fact that it starts out as a fixed-rate loan means that your monthly payments will also be lower at first.
The advantage is that lower monthly installments will help put you in line for a larger borrowed amount from the lender. However once the fixed period expires, your interest rate can escalate, resulting in higher monthly payments for the remaining period of the loan term.
Balloon Payment
The balloon payment refers to the final lump sum that makes up a sizable portion of this loan structure, which is the last payment the borrower makes on the loan to pay it off in full. The rest of the lending term is comprised of smaller monthly payments that take place at regular intervals.
Be aware that this loan has negative implications if your financial situation isn’t stable enough and you find yourself unable to afford the balloon payment at the end. This justifies its other name – a bullet loan – as you could be hard-hit by this big payment which could result in your assets being seized by the bank or lender. It is common for lenders to take out a balloon loan as their second mortgage plan, and this kind of lending scheme can be accompanied by either a fixed or floating (adjustable) interest rate.