We all find ourselves at some point in life needing a helping hand to achieve our financial goals. Whether to purchase a house, furnish our homes, start a business, or buy a car. There are many types of loans offered by banks to help you achieve all these. The various types of loans are categorized either by their repayment terms or by what the loan applicant needs the funds for.
Types of Loans by Repayment Terms
The contractual terms by which the lending financial institution offers loans to the loan applicant differ and this gives rise to different types of loans. The types of loans offered by banks include:
Fixed Rate Loans
These are loans that charge a fixed interest rate over the life of the loan. In such a loan agreement, the applicant services the loan with equal regular payments at an equal interest rate. Fixed interest loans provide the loan applicant with the peace of mind of not having to worry about increased payments and therefore make planning easier. In some instances, the payment will vary slightly to cover taxation and maintain a favorable escrow balance. Fixed rate loans are common when taking out a mortgage.
Variable Rate Loans
Variable interest loans charge a fluctuating interest rate over the life of the loan. The fluctuations are due to changing market rates and underlying benchmarks or indices. Such types of loans usually attract lower interest rates compared to fixed interest loans. They are popular with home owners or applicants seeking small business loans, student loans, or car loans.
These types of bank loans are typically repaid in periodic equal amounts over the entire life of the loan. The repayment period may range anywhere between a few months to a few decades. They have very specific repayment terms with fixed start dates, end dates, monthly repayment dates, and interest charged.
When you take out a loan, it is usually on the promise that you will repay it. To hold you to your promise, it is at times necessary to provide collateral. This safeguards the lenders interests in case the borrower defaults on repaying the loan. For example, if you take out a car loan, the lender may consider the car as collateral and in case you are unable to pay, the lender then repossesses the car to recover the borrowed money.
Banks will sometimes offer some clients a loan without necessarily asking for collateral. Such loans are usually only offered to customers with a good track record of repaying loans and with high credit ratings. The amounts of interest rates charged on unsecured loans are usually higher than those charged on secured loans. The interest rate correlates with the applicant’s credit scores, meaning if you have a good credit score you are charged a lower interest rate than someone with a poor credit score.
Sometimes it is more prudent to take out a loan based on one type of repayment method and in the course of the life of the loan switch to another repayment type. For instance, many home owners take out a loan to purchase the home at a fixed interest rate then after some time when the market conditions are favorable, they change it to a variable rate loan. Such types of loans are known as convertible loans. These types of loans are favored by business startups and home owners.
Types of Loans by Fund Usage
The types of bank loans are further categorized according to what the applicant intends to use with the loans. Here are some of the more common types of loans offered by banks.
Fixed Rate Mortgage
This is one of the types of loans that an applicant may use to purchase a home. With a fixed rate mortgage, the lender defines the interest rate that will apply on each payment throughout the entire life of the loan at the time of the applicant taking the loan. This type of loan enables the home owner to plan payments without worrying about fluctuating market rates.
Adjustable Rate Mortgage
An Adjustable Rate Mortgage (ARM) is one of the types of loans offered by banks to homeowners. The interest rates for an ARM are typically lower than for a fixed rate mortgage and vary depending on specific benchmarks. The loan initially attracts a fixed interest but after a specified period of time the interest rates are periodically reset based on additional spreads, taxation, and benchmarks. These types of mortgages are also know as floating rate mortgages or variable rate mortgages. A 2/28 mortgage is an example of an adjustable rate mortgage whereby the applicant will be required to pay a fixed interest rate for the first two years then pay variable interest charges for the following 28 years.
A buydown mortgage is a financial facility offered by home sellers to home buyers. The home seller puts an amount in escrow to enable buyers easily qualify for a mortgage. The buyer gets to pay lower monthly payments in the beginning which may increase with time. The seller usually raises the total buying price to recoup costs and earn a profit.
Personal loans are usually small to medium sized loans offered by banks to individuals. The loan may be used to settle personal debts or buy household goods, clothing, fund short term inexpensive projects, or whatever else the applicant may require the loan for. They typically have a short repayment period of only around 2 years and are generally unsecured. However, the applicant will have to first show an ability to repay the loan before they can qualify. This can be done by some form of income verification and by proof of owned assets that can cover the loan amount.
The pursuit of higher education is filled with many expenses. Banks offer various types of loans to assist those in need of funds for their education. These consist of private student loans and loans to cover internship costs.
According to US statistics for the year 2011, there were more than 12 new cars sold nationwide. Over 80% of these were purchased using car loans. Vehicle loans are one of the most popular loan types. Car dealers partner up with financial institutions to make it easier for their customers to purchase cars on affordable and easy to pay terms.
Line Of Credit
Most businesses have running expenditures that have to be met on a continuous basis. Banks offer a limited line of credit to qualified firms so they can continue with their business ventures even when they are low on funds. A bank may for instance, offer a company a line of credit for $40,000. This means that the company can make payments and purchases with the banks money to a level not exceeding $40,000. A line of credit is like a business checking account that attracts interest charges on withdrawals.
Credit Card Loans
Each time you use a credit card, you are basically taking out a loan with a promise to repay it as part of your bills at a later date. Credit cards come in handy because they are widely acceptable and you do not have to go through an application process each time you want to make a purchase or need extra cash. Most financial institutions have a fast review process for credit card applicants and applications can even be made online or over the phone.
At times, it is either impractical or cost-deficient to purchase equipment to conduct business. In such instances, it may be better to lease some machinery and other equipment. Banks offer equipment leasing as part of their financial assistance for business growth.
Letters Of Credit
Businesses that have interests abroad usually need a form of guarantee that payments will be completed once contract terms have been agreed. Therefore, banks offer letters of credit to assure overseas suppliers and business partners of the availability of funds to pay for the business contracts they engage in.
Some financial institutions offer short term loans to clients against an expected future income. They are usually available to those who earn a fixed or regular income. However, cash advances are mostly impractical for projects that require large funding as they have very short repayment periods and attract high interest rates. Moreover, they are not tax deductible.
Small Business Loans
Most local banks offer loans to startups and other small to medium size businesses. There are also government institutions such as the Small Business Administration (SBA) that offer low interest loans. These loans usually require personal guarantees from the business owner(s) and the applicants may be required to put up their personal assets as collateral.
See Also : Small Business Banking and Loans
One can approach a bank to get funding for purchasing a computer from one of the major computer makers. The applicant typically picks out the computer and the financial institutions draws out a check to be delivered to the computer merchant. These are typically short term loans with a repayment period of up to 2 years.
While this article does not feature each and every kind of bank loan available, these are the most common funding options for those who need financial help to grow their business or achieve their personal goals. Before taking out a loan, you should take into serious consideration the terms, interest charged, repayment periods, and collateral required.