What is a loan?
Part I: As you read the text, complete the following notes and questions to help you better understand the ins and outs of
taking out a loan.
1. Define the following terms
Creditor
Debtor
Collateral
Co-signer
Line of credit
Principal
2. When would you be more likely to take a single-payment loan than an installment loan?
3. What would happen if you did not pay back your loans, as contracted by your promissory note?
Part II: Explain the key differences in the types of loans.
When you’re borrowing money, you'll likely need to make a decision about a secured loan vs. unsecured loan and the
types of payments you can make on those loans.
A secured loan is one that is connected to a piece of collateral - something valuable like a car or a home. With a secured
loan, the lender can take possession of the collateral if you don't repay the loan as you have agreed. A car loan and
mortgage are the most common types of secured loan.
An unsecured loan is not protected by any collateral. If you default on the loan, the lender can't automatically take your
property. The most common types of unsecured loan are credit cards, student loans, and personal loans.
Secured loan vs. unsecured loan: which is right for you?
There are a couple factors that go into deciding on a secured vs. unsecured loan. A secured loan is normally easier to get,
as there's less risk to the lender. If you have a poor credit history or you’re rebuilding credit, for example, lenders will be
more likely to consider you for a secured loan. A secured loan will tend to also have lower interest rates. That means a
secured loan, if you can qualify for one, is usually a smarter money management decision versus an unsecured loan.
Finally, a secured loan will tend to offer higher borrowing limits, enabling you to gain access to more money.
If you have loans and you're having trouble paying your bills, it's usually more important to first pay down a secured loan
vs. unsecured loan. If you fail to make your car payment, for example, you may end up losing your vehicle. But keep in
mind failing to make timely payments on an unsecured loan can drive you deeply into debt, as the interest rates on an
unsecured loan may be quite high.
However, the money you borrow is not the only debt you owe to your creditors. The principal plus additional fees for
borrowing money, called interest, are owed. A variable or adjustible interest rate loan is a loan in which the interest
rate charged on the outstanding balance varies as market interest rates change. This market rate is set by the Federal
Reserve. As a result, your payments will vary as well (as long as your payments are blended with principal and interest).
Fixed interest rate loans are loans in which the interest rate charged on the loan will remain fixed for that loan's entire
term, no matter what market interest rates do. This will result in your payments being the same over the entire term.
Whether a fixed-rate loan is better for you will depend on the interest rate environment when the loan is taken out and on
the duration of the loan. When a loan is fixed for its entire term, it will be fixed at the then-prevailing market interest rate,
plus or minus a spread that is unique to the borrower. Generally speaking, if interest rates are relatively low, but are about
to increase, then it will be better to lock in your loan at that fixed rate. Depending on the terms of your agreement, your
interest rate on the new loan will remain fixed, even if interest rates climb to higher levels. On the other hand, if interest
rates are on the decline, then it would be better to have a variable rate loan. As interest rates fall, so will the interest rate
on your loan.
This discussion is simplistic, but the explanation will not change in a more complicated situation. It is important to note
that studies have found that over time, the borrower is likely to pay less interest overall with a variable rate loan versus a
fixed rate loan. However, the borrower must consider the amortization period of a loan. This is how long you have to pay
off the loan in installment payments of principal and interest. The longer the amortization period of a loan, the greater the
impact a change in interest rates will have on your payments. As an example, adjustable-rate mortgages are beneficial for
a borrower in a decreasing interest rate environment, but when interest rates rise, then mortgage payments will rise
sharply.
5. Calculate and answer the following questions based on the information above.
a. Using the formula I =PRT (Interest = Principal x Rate x Time), how much interest would you pay if you borrowed
$5,000 at a 12% interest rate for 90 days?
b. What kind of loan is this? How do you know?
6. True or False?
a. A secured loan is a type of loan in which the borrower has to pledge an asset as assurance for the loan. _____________
b. An unsecured loan typically has low interest rates. _____________________
Source: http://www.consumercredit.com/secured-loan-vs-unsecured-loan
http://www.investopedia.com/ask/answers/07/fixed-variable.asp