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The definition of loan states, that it is a contractual promise of a debtor to repay in the future a
given amount of money, in exchange for the promise of a creditor to give (now) another sum of money to the debtor.
To express it in simple words - a debtor borrows money from the lender and then pays back
the capital (the sum of money previously received) increased by the interest. Usually,
payments are divided on a monthly basis over the payoff period.
There are many kinds of loans offered by banks and other financial institutions, and many
possible situations in which people need to get a loan. This short article will show
the basic typology of loans. In fact, there are two main cathegories
of loans - secured and unsecured. All types of loans
can be classified in one of the above groups.
A loan is secured when it is backed up by some asset (for exapmle a car or a property) - such asset is called
a collateral. The creditor is given a lien on the title to the collateral and
if the borrower for some reason is no longer able to pay off the loan, the creditor
has the right to repossess the pledged asset and sell it, in order to recover the unpaid
sum of the loan.
A loan is unsecured when there is no collateral. It means that the debt is not
secured by the borrower's assets.
The most common types of secured loans are:
- mortgage loan - the debt is secured by the lien on the rights to the property (for example a house);
- auto loans - the debt is secured by the lien on the title to the car.
Usually (but not always), the type of security is strictly connected to the purpose
of the credit: if you buy a house, you get a mortgage loan, if you buy a car,
you get an auto loan. In most cases, the payoff period of mortgage loans can be very long
(30 years and more), and the payoff period for auto loans is much shorter (usually up to 5 years).
The most common types of unsecured loans are:
- credit card debt;
- credit line on a bank account;
- payday loans (a short term loan - usually for up to 2 weeks -
which is payed off on the next payday of the debtor);
Unsecured loans are usually given for a shorter period of time than the secured ones.
They also do not have a specific purpose. Because the creditor takes much more risk,
unsecured loans are always more expensive (the interest is higher).
Finally, loans can be divided in two groups, depending on the kind of the debtor. Personal loans
are given to private people in order to cover expenses of their personal life (family, household expenses, etc.).
Student loans are intended to finance costs of studying of young people.
Business loans are given to companies or other businesses in order to enable financing for their
investment needs.
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