Whether you’re considering taking out a loan to buy a car, house, or other expensive item, you’ll want to understand what you’re committing to.
When you take out a loan, a lender is granting you use of their money. In exchange for this loan, you are agreeing to pay interest on the money you’ve borrowed.
The interest, a small percentage of the loaned amount, can be “fixed” or “variable.” Fixed rates stay the same for the life of the loan, while variable rates can change over time and are usually based on the standard market rate. For example, if you take out a loan with a variable rate at prime +2, that means you are agreeing to pay two percent more on the prime interest rate.
A loan will also be “secured” or “unsecured.” If you take out a secured loan, you are offering collateral. The lender can take this collateral if the loan goes unpaid. An unsecured loan, on the other hand, does not require collateral, but usually has a higher interest rate. Student loans usually are the exception, as they don’t require collateral but still have low interest rates.
The third component is the “term” of the loan. This is the length of time the borrower has to repay the loan. A longer term typically means a higher interest rate.
While responsible repayment of a loan can enable you to make major purchases and grow your credit, you’ll want to understand the commitment you are agreeing to. Don’t jeopardize your credit score and financial standing by taking out a loan without assessing your budget and ability to pay it off.