Different Types of Loans

All loans, no matter what they are, are either secured or unsecured. Knowing the difference can better help you understand how they work and what to expect when applying for one.

Secured Loans

A secured loan is one that relies on an asset, such as a home or car, as collateral for the loan. In the event of loan default, the lender can take possession of the asset (foreclose on a home or repossess a car, for example) and sell it to recover the amount of money loaned. For this

reason, interest rates for secured loans are often lower than those for unsecured loans.

In many cases, such as in the purchase of a home, the asset to be used as the collateral will need to be appraised before the terms of the loan can be set.

Examples of secured loans are:

1. •        Car loans
2. •        Boat (and other recreational vehicle) loans
3. •        Mortgages
4. •        Construction loans
5. •        Home equity loans
6. •        Home equity lines of credit
7. ·        Unsecured Loans

Unsecured loans do not require the borrower to put forth an asset for collateral. The lender relies solely on the borrower’s credit history and income to qualify him for the loan. If the borrower defaults, the lender usually has to try to collect the unpaid balance through a variety of efforts which may include using collection agencies, freezing accounts, lawsuits, and garnishing wages. Because there is a considerably higher assumption of risk on the lender’s part with an unsecured loan, the interest rate is usually much higher.

They are often more difficult to obtain and the amounts loaned are usually lower than that for secured loans.

1. Examples of Unsecured Loans are:
2. •        Personal loans
3. •        Personal lines of credit
4. •        Student loans
5. •        Credit cards/department store cards
6. •        Payday Loans

Payday loans are relatively new on the loan scene. They are short-term loans borrowed using the borrower’s next paycheck as guarantee for the loan so, in a way, they are secured. However, payday loans have notoriously high annual percentage rates (APRs) and can be difficult to pay off. Banks do not generally offer Payday bloans. Most establishments offering them are private companies with separate storefronts.

Title Loans

A title loan, also fairly new, is a type of secured loan where the borrower can use

their vehicle title as collateral. Borrowers who get title loans must allow a lender to

place a lien on their car title, and temporarily surrender the hard copy of their vehicle title, in exchange for a loan amount. When the loan is repaid, the lien is removed and the car title is returned to its owner. If the borrower defaults on their payments then the lender can repossess the vehicle and sell it to repay the borrowers’ outstanding debt. Typically, the same companies that offer Payday loans will also offer title loans.

Student Loans

Student loans are, of course, used to get a person through college or other educational institution. There are many different types of student loans including:

•        Stafford loans, the most common federal education loans

•        students receive. They can be either subsidized or unsubsidized.

•        Perkins loans, low-interest federal loans, administered by the school, for students who demonstrate exceptional financial need.

•        PLUS loans, usually used to cover expenses not met by other federal

•        financial aid. These can be taken out by dependent students’ parents or by graduate students.

•        Institutional loans, non-federal aid that schools loan their students.

•        Private loans, usually sought by parents of students ineligible

for other aid or those who do not receive enough aid to cover the cost of attendance. In many cases, these must be secured by some form of collateral.

Mortgages

Mortgages are probably the most complicated types of loans and have the most variations, the first being who is underwriting or guaranteeing the loan. A mortgage loan might be any one of the following:

Conventional

Conventional loans are those that aren’t insured by a government agency like the Federal Housing Administration (FHA), Rural Housing Service (RHS), or the Veterans Administration (VA). Conventional loans may be conforming, meaning they follow the guidelines set forth by Fannie Mae and Freddie Mac, or non-conforming, meaning they don’t meet Fannie and

Freddie qualifications.

•        FHA Loans

FHA mortgage loans are insured by the government through mortgage insurance that is funded into the loan. First-time home buyers are ideal candidates for an FHA loan because the down payment requirements are minimal and the borrower’s FICO credit score does not affect the interest rate.

VA Loans

This type of government loan is available to veterans who have served in the U.S. Armed Services and, in certain cases, to spouses of deceased veterans. The main benefit to a VA loan is the borrower does not need a down payment. The loan is guaranteed by the Department of Veteran Affairs, but funded by a conventional lender.  Mortgage loans also vary greatly by repayment parameters. These days there are many options including:

Fixed-Rate Mortgages

A fixed-rate mortgage is one in which the interest rate on the note remains the same through the term of the loan. As a result, the payment amount and the duration of the loan are fixed. The borrower makes a consistent payment, usually monthly, for a specified number of years until

the loan is paid off. These payments are amortized, meaning that, as time goes by, more of each payment is applied to the principal than to interest.

The most common type of fixed-rate mortgages are 30 year and 15 year but other variations are also available. Adjustable-Rate Mortgages An adjustable-rate mortgage, commonly called an ARM, is one in which the interest rate fluctuates. It can move up or down monthly, semi-annually, or annually. In many types of ARM, the rate remains fixed for a period of time before it adjusts. For example, the rate on a 5-year ARM with a 30-year term will not be adjusted for the first five years.

With any ARM, it is important to note how frequently the interest rate can adjust, plus the index and the margin used to set the new interest rate. In other words, if it is tied to the prime rate and that rate jumps by 2 points in a year, the ARM rate could jump as well. However, there is often

a cap put on how much the rate can be raised in a single adjustment period.

Interest-Only Mortgage

Interest-only loans contain an option to make an interest-only payment. The option is available only for a certain period of time. However, some mortgages are indeed interest only and require a balloon payment, consisting of the original loan balance at maturity.

Balloon Mortgages

These mortgages are structured with a payment schedule similar to that of a thirty year fixed rate loan, although the term of the balloon loan is shorter, most often spanning five to seven years. At the end of the loan term, the outstanding balance must be paid in one lump sum, often by refinancing the home.

Reverse Mortgages

Reverse mortgage are available to any person over the age of 62 who has enough equity in their home. Instead of making monthly payments to the lender, the lender makes monthly payments to the borrower for as long as the borrower resides in the home (or it can be an up-front lump sum payment). The interest rate can be fixed or adjustable. When the

homeowner moves out or passes, the house is sold and the mortgage is paid off.

Home Equity Loans

A home equity loan is a loan for a fixed amount of money that is secured by a home. The borrower agrees to repay the loan with equal monthly payments over a fixed term, just like the original mortgage. If the borrower defaults on the payments, the lender can foreclose on the home. A homeowner must have equity in the home to get a home equity loan, thus the name. The equity is the appraised value of the home minus the amount still owed on the original mortgage. Usually, the maximum loan is for a certain percentage, say 90%, of the total value of the home minus the amount of the original mortgage.

Home Equity Lines of Credit

Like a home equity loan, a home equity line of credit — commonly known as a HELOC —requires the borrower to use his home as collateral for the loan. The HELOC, however, works much differently. It is a revolving line of credit, much like a credit card, against which the homeowner can borrow by writing a check or using a check card connected to the account.

The credit can be used as needed, however, the total amount that can be borrowed is set much like the Home Equity loan. Because a HELOC is a line of credit, the borrower makes payments only on the amount actually borrowed, not the full amount available, which can be an advantage for many people. Also, even after paying down a HELOC, the homeowner can re-borrow amounts up to the credit limit of the HELOC. Benchmark Community Bank tries to make the advice on its Financial Answer Center as useful and reliable as possible.

Information has been gleaned from a number of expert resources. However, the purpose of this advice section of the website is to provide customers and visitors with general guidance and useful tips only. It doesn't necessarily deal with every important topic or cover every aspect of the topics with which it deals and might not be relevant or appropriate in all circumstances. It is not designed to provide professional advice and should not be relied on as such. If in any doubt, you should consult an appropriately qualified expert for specific advice before acting on any of the information contained in the Answer Center.