5 of the most common bank loans and how they work

Article Category: Finance  |   

The world is money lending is great place to be in if you know how to handle your cash. With a little financial cunning and a few deft swipes of a pen, you can easily finance a major extension to your house or pay for your child's first car. But have you ever wondered what all those options are that the banks keep throwing at you? If so, then I have just what you need: a guide to 5 of the commonest bank loans currently available and information on how they work.

What are open-ended loans?

A couple applying for a bank loan - photo

Open-ended loans do exactly what they say on the tin - they allow you to keep borrowing more and more money up to a certain limit. Now, if you're not careful, this can be incredibly unhealthy for your bank balance, your mortgage or even your future welfare.

If you haven't heard of an open-ended loan before then that's ok - most people haven't. Basically, what we're talking about are lines of credit and credit cards. Now you may not need me to tell you the biggest problem with this type of borrowing. But, for anyone who's unsure, it's the interest rates. Borrow too much and you could find it incredibly hard to clear the balance.

What are closed-ended loans?

At the opposite end of the money spectrum, we have closed-ended loans. As you've probably already worked out, these are for fixed sums and can't be extended. This means you don't have an available credit limit - you simply borrow what you need and continue to pay off the sum until your debt is cleared.

The closed-ended loan is one of the most common ways to borrow from the banks. The obvious downside is that, once you've got the money, you'll either have to pay it off or take on another, larger debt if you need more money. The most common closed-ended loans available are mortgages, student loans and auto purchase loans.

What are secured loans?

Another well-known and popular method of borrowing money, secured loans are granted in return for collateral. In most cases, this involves some asset you own (or, if using a guarantor, something they own). If you default on repayments your collateral belongs to the lender.

Now, this might seem a little harsh but the banks and financial houses are protecting their interests and customers. You won't be offered a sum you can't possibly repay so there'll be no underhand tactics there. Also, the amount you're loaned may be subject to a valuation of the asset you're offering as collateral and adjusted based on the lender's valuation.

What are unsecured loans?

Unsecured loans are the complete opposite of secured loans in just about every imaginable way. You don't have to offer an asset as collateral as the amount you can borrow depends on your credit history and the amount you earn. In fact, if you have a bad credit history then you can probably forget about this type of loan right now.

Not only is this type of loan more difficult to secure but you're going to be hit with higher interest rates than those associated with a secured loan. This extra premium is due to the inherent risk associated with unsecured money lending - if you default, the lender has to spend money on debt collectors and, if they fail to collect what's owed, start a lawsuit to recover their money.

What are payday loans?

Now I'm sure you've heard of payday loans which, some would say, deservedly have a really bad reputation in financial circles. Until a recent clamp down on seller practises, interest rates could easily reach thousands of percent. This may not seem much when you borrow $1,000 over a week, but miss your payments and you'll learn how punishing an experience these loans can be.

Although payday loans have a bit of a bad name, they're still incredibly popular. The ease and speed with which you can get hold of money from a lender makes this form of money lending incredibly popular. Most lenders promise to make lending decisions in minutes and, if your application is successful, the money can be in your bank account in a matter of hours.

To Conclude

Four of the most common and one of the most dubious forms of loan. There are plenty more out there but, for most of you, these four should be more than adequate to help you decide what type of loan you need (hint: avoid payday loans at all costs).

To help you work out what repayment amounts you might pay on a loan, we've created a loan calculator tool. You can also calculate the interest rate you are currently receiving on your loan by using our interest rate calculator.

Written by James Redden

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Last update: 13 November 2013

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