What is the definition of a loan?
A loan is a debt, either money or property, given to a borrower by a lender, where repayment is in a future date, at a given interest rate. A loan is a contract between the two parties stating the principal amount borrowed, the interest rate and the date of payment. Both the borrower and the lender can either be a financial institution, a country, an organization or an individual.
1. Secured loans
This type of loan is where a borrower pledges assets as collateral to the loan in case of a default.
The most common examples of secured loans include mortgages and auto loans. A mortgage is that loan which a borrower acquires to purchase property. The property bought is usually the collateral which the lender can acquire in case of a default.
In auto loans, the borrower pledges the car he purchases as collateral.
2. Unsecured loans
Here, the borrower does not pledge any asset as collateral to the loan. These types of loans usually attract higher interest rates than secured loans due to the higher risks of default.
In a default case, the lender can sue the borrower in order to get judgement for breach of contract to enable him to acquire the borrower’s assets which are not collateral to another secured loan.
Secured lenders receive priority over unsecured lenders in the dividing of the defaulting borrower’s assets.
Examples of unsecured loans include bank overdrafts, credit card loans and some debts from friends.
3. Subsidized loans
Subsidized loans refer to those that have low or no interest rates at a specific time due to a specific subsidy. Here, the government pays the interest to incur during a specific period of time.
These loans are only open to a specific group of people. A student loan is an example which students who require financial support receive to cater for cost of higher education.
4. Concessional loans
Concessional loans are popular because of their generous nature in terms of interest rates.
Usually, they attract lower interest rates than the rates in the market.
Another attractive feature is the grace period which they offer. During this period, no fees apply and delay in payments does not lead to default or invalidation of the loan.
5. Open-ended loans
Terms of an open-ended loan allows the debtor to borrow more than once in a certain period of time. Basically, these loans have a credit limit against which the borrower cannot exceed.
Credit cards are the most common types of open-ended loans where every purchase reduces the credit at the card holder’s disposal.
6. Close-ended loans
Debtors can borrow again only after clearance of a previous debt in a close-ended loan. The debtor can pay a single debt in a number of phases but borrow again on completion of repayment.
It is important that potential borrowers check carefully on the types of loans so as to fully understand the options open to them. It is advisable to apply for the loan that suits your needs best and pay attention to ability to pay depending on the interest rates.
For instance, a low interest rate loan like the concessional loan is more appealing than most of the other types of loans. Students should apply for the students loans as these loans have a subsidy thus low or no interest.
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