Americans and the word debt often seem like they go hand-in-hand. And for good reason.
U.S. household debt hit an astonishing — and record-breaking — $14.6 trillion in 2021, according to Debt.org. Granted, this high total was partially influenced by the pandemic. And this figure is total debt, which includes non-loan amounts like money owed on credit cards.
But, if used wisely, debt can be a tool. Contrary to the opinion of some personal finance gurus, debt — and specifically speaking, loans — can help you pay for a four-year education or buy a home. Loans are also useful instruments if you need to pay for a surprise expense and choose to finance it over dropping the cash which you may or may not have.
In this article, we’ll discuss loans, the different types and how they work.
What Is a Loan?
A loan is an amount of money a person borrows from a person or company. The entity lending the money — the lender — disperses the loan amount to the borrower or payee. Loans come with interest rates and a set number of years the borrower has to pay it back. It’s the role of the borrower to steer clear of financial trouble and make regular monthly payments to keep the loan in good standing.
To get a loan — and a favorable interest rate — lenders usually require that a borrower has a good credit score and other creditworthiness factors. (Although you can shop multiple lenders and find one to work with you and your situation.)
There are secured loans and unsecured loans:
- A secured loan is backed by collateral, like your house with a home equity loan.
- Alternatively, an unsecured loan doesn’t require any collateral, like a student loan.
For the latter, a lender might review your credit score and credit history to determine whether or not to approve your loan application.
What’s a Loan Interest Rate?
Interest rates refer to the amount of money you pay on top of the loan amount you borrowed. For example, if you finance a used car through an auto dealership, the dealer might add a 5% interest rate (which gets worked into the amount you pay for your monthly car payment). This fee is imposed by the lender; it’s how they make money off the loan.
There are two types of rates:
- Fixed interest rate: This is a set rate for the entirety of your loan.
- Variable interest rate: This is a fluctuating rate throughout the life of your loan.
Loans …….