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Types of loans
There are two basic types of loans:
Secured loans are guaranteed (secured) by an asset (collateral) owned by the borrower.
For example, with a car loan, the car acts as collateral; if you don't repay the loan under the agreed-to terms, the lender can take possession
of it, leaving you with nothing except a damaged credit rating. Home mortgages and car loans are the most common secured loans.
Unsecured loans are not tied to the borrower's assets.
Basically, the lender trusts that you are creditworthy and will repay the loan. Because lenders have fewer repayment options when borrowers
default, unsecured loans tend to have higher interest rates and shorter terms than secured loans. Credit cards, bank overdrafts, student and personal
loans are common unsecured loans.
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Interest rate varieties
Lenders make money on loans by charging interest. There are two types:
Fixed rate loans carry interest rates that are "fixed" (remain the same) throughout the life of the loan, provided
you abide by the terms of the loan.
Variable (or adjustable) rate loans are tied to specific market indices and adjust periodically, based on how the index performs.
For example, variable rates tied to the prime rate will go up or down, depending on the current prime rate.
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Comparing fixed rate and variable rate loans
Your loan's interest rate type can impact your ability to afford payments, so fully understanding the loan's terms and conditions is vital.
Both types have their advantages and disadvantages:
It is often harder to qualify for fixed-rate loans if your credit score is low; also, monthly payments may initially be higher than with
variable-rate loans. However, payment amounts are predictable over time so budgeting is easier.
Variable-rate loans usually offer lower introductory rates and thus can be more affordable initially. But once the introductory period ends and the rate readjusts, if the underlying market index has increased significantly, so will the monthly payment. Keep in mind that interest rates on variable-rate loans can increase or decrease throughout the course of the loan.
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Loan fees, penalties and other charges
In addition to loan interest, borrowers may also be responsible for other fees and charges that are outlined in the loan agreement and that can
significantly boost the overall loan cost. For example:
Mortgages typically have numerous additional costs including fees for loan origination, appraisal and document preparation, as well as
broker fees, property taxes and insurance.
Car loans also carry fees (and tax and insurance responsibilities), so be sure to include them when budgeting how much you can
afford to borrow.
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Credit cards may have various fees and penalties.
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Certain types of student loans charge origination and other fees.
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Shopping for loans
Each type of loan has numerous lending options available. Some institutions, like banks and credit unions, offer everything from small
personal loans to car loans to home mortgages. Others, like mortgage brokers, specialize in only one type of loan.
A few loan shopping tips to share with your teens:
First, know what you can afford in total monthly payments. Be sure to include things like down payment amount, sales and property taxes and insurance. For interactive calculators that can help you estimate car loan and mortgage costs, visit www.mindyourfinances.com/calculators.
Ask acquaintances who they have used and whether they were satisfied with the service.
Read newspaper ads to get a sense of locally available rates and terms; but realize they may be teaser rates targeting
top-credit customers.
Review Web sites to compare rates and terms from a number of lenders at once.
When car shopping, arrange your own financing first, then compare the loan you were able to qualify for on your own with what the dealer or manufacturer is offering.
When mortgage shopping, investigate options on your own before talking to a mortgage broker.
Avoid so-called "payday" loans designed to tide you over until the next paycheck. Their high fees and penalties can
effectively raise the interest rate to 400 percent or more.
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