What to Look for in a Loan

Do you need financing for personal or business reasons? Do you plan on buying a home or an automobile sometime in the near future? If you said 'yes' to either of these questions, chances are you will be looking for a loan.

There are a wide variety of loans available, from business lines of credit to credit cards to payday loans. Each type is suitable for certain types of uses and has its own advantages and drawbacks. In general though, there are certain key features all loans have.

Does the loan require collateral?

Sometime, you put up collateral when taking out a loan. For example, if you get a margin loan from your stock broker, you are using your stock as collateral to borrow money. Other times, you are getting a loan to buy a piece of collateral, such as a car loan. When you borrow money to buy a car, the car also acts as the collateral. So if you fail to make payments to your bank and default on the loan, the bank can repossess the car to mitigate its losses.

Other loans have no collateral whatsoever. Such examples of these unsecured loans are credit cards and business unsecured lines of credit.

What is the loan's interest rate?

All creditors charge interest. Sometimes, there is a flat interest rate throughout the loan as well as fees and penalties if you are late making a payment. Other times, as is common with credit cards, the rate is variable. It's very important to know what the interest rate is on any loan you take out since that is how much you are 'paying' to borrow that money.

Many people get into trouble when they take out loans with variable interest rates. The sub prime crisis illustrates this perfectly. People took out loans with variable interest rates for houses that they probably could not afford. At first, the interest rate on the loan was low, due to low prevailing rates. However, over time, the interest rate and payment amounts shot up. They eventually defaulted due to the inability to pay the mortgage, and their homes went into foreclosure.

Certain types of loans in general have higher interest rates than others. For example, a mortgage typically has a low interest rate, since you are buying a piece of collateral (the house). Nowadays, mortgage interest rates have dropped like a rock. Thirty year low fixed rate mortgages can be had for fewer than six percent.

In contrast, payday loans charge absurd interest rates. People often have to pay double digit interest on a loan lasting a few weeks, meaning the APR is well over 500%!