Fin Lit: Loans and Credit Cards Part 1 - Loans

​Loans and Credit Cards
Part 1: Loans

By george.shreve george.shreve

Interest, Term Loans, and Revolving Loans

Interest

The cost of borrowing money. It's the fee a lender charges a borrower, usually expressed as a percentage of the principal (the amount borrowed). It's essentially the price you pay to use someone else's money.

Term Loan

A loan for a specific amount that's paid back over a fixed period of time (the term) with regular, scheduled payments. Once the loan is paid off, the account is closed.

• Example: A car loan or a mortgage.

Revolving Loan

A loan that allows you to borrow up to a certain limit, pay it back, and then borrow again up to that limit without reapplying. The amount you pay back frees up more credit to use.

• Example: A credit card or a home equity line of credit (HELOC).

Secured Loans and Collateral

Secured Loan

A loan that is backed by collateral. If the borrower defaults on the loan, the lender can take the collateral to recover their money.

• Collateral: An asset a borrower pledges to a lender as security for a loan. This could be a house, a car, or even savings.

Default and Repossession

• Default: When a borrower fails to make payments on a loan as agreed.

• Repossession: The process by which a lender takes back the collateral used to secure a loan after the borrower defaults.

• Example: If you stop making payments on your car loan, the lender can repossess the vehicle.

Fixed vs. Variable Interest

Fixed Interest Rate

An interest rate that remains the same for the entire term of the loan. Your monthly payments for principal and interest won't change, which makes budgeting easier.

• Pros: Predictable payments and protection from rising interest rates.

Variable Interest Rate

An interest rate that can change over the life of the loan. It's usually tied to an index, like the prime rate, and will adjust up or down.

• Pros: Payments can be lower initially if the rate starts low.

• Cons: Payments can increase significantly, making them unpredictable.

Sources of Loans

• Banks: Traditional financial institutions that offer a wide range of loans, from personal loans to mortgages.

• Credit Unions: Nonprofit financial cooperatives owned by their members. They often offer lower interest rates and fees compared to banks.

• Savings and Loan Associations (S&Ls): Financial institutions that primarily take savings deposits and provide mortgage loans.

Point-of-Sale (POS) or Seller Loans

A type of loan offered directly by a retailer or a third-party lender working with the retailer at the time of purchase.

• Examples:

  • A car dealership offering financing for a new vehicle.

  • A furniture or appliance store offering "same as cash" or installment plans.

  • How they work: The seller or lender approves you for a loan to buy their specific product. Payments are then made to the lender over a set period.

Mortgage Lenders and Brokers

Mortgage Lender

A financial institution, like a bank or credit union, that originates and funds mortgages. They lend their own money to borrowers to purchase a home.

Mortgage Broker

An intermediary who connects borrowers with lenders. A broker doesn't lend money themselves but helps you find the best loan terms and rates from various lenders. They essentially act as a matchmaker.

Modern Peer-to-Peer (P2P) Lending

A system that allows individuals to borrow and lend money to each other directly, without a traditional bank as the intermediary.

• How it works: Online platforms, like LendingClub or Prosper, connect people who want to borrow money with people who want to invest. Borrowers submit a loan request and investors fund the loan.

• Benefits: Can offer better interest rates for borrowers and higher returns for lenders compared to traditional options.

The Loan Application Process

Loan Application

A formal request to a lender for a loan. The application typically requires personal and financial information, such as income, employment history, and other debts, so the lender can assess your creditworthiness.

Co-signer

A person who agrees to be equally responsible for a loan's repayment alongside the primary borrower. If the primary borrower fails to make payments, the co-signer is legally obligated to pay the debt.

• Purpose: A co-signer can help a borrower with limited or poor credit get approved for a loan.

Terms of a Loan

APR (Annual Percentage Rate)

The true cost of a loan, expressed as a yearly percentage rate. It includes both the interest rate and any fees associated with the loan.

Principal Amount - The original amount of money borrowed.

Length of Loan - The period of time over which you agree to repay the loan.

Fee Amount - Any fees associated with the loan, such as origination fees or closing costs.

Potential Late Fees or Early Payoff Fees

Late Fees: Charges for making a payment after the due date.

Early Payoff Fees (Prepayment Penalties): A fee some lenders charge if you pay off your loan before the scheduled end date.

Types of Loans

• Vehicle Loan: For purchasing a car, motorcycle, etc. Usually a secured loan with the vehicle as collateral.

• Personal Loan: An unsecured loan for various purposes, like debt consolidation or a large purchase.

• Mortgage: A loan used to finance the purchase of real estate.

• Home Equity Loan: A secured loan that allows you to borrow against the equity in your home. It's a lump sum paid back over a fixed term.

• Home Equity Line of Credit (HELOC): A revolving loan where you can borrow money as needed up to a certain limit, using your home's equity as collateral.

• Student Loans: Loans specifically for paying for education and related expenses.

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