Loans 101: A Complete Guide to Loans for Dummies

Posted on Nov 17 2014 - 3:04pm by admin

We’ve all had that experience: running out of money when we need it. Or maybe you aren’t out of money, but you need money for other purposes, say buying a mortgage as a single mom or attending college as a single parent. All of these things are costly – if you don’t have the money, you don’t have the money.

This is where a loan can come in handy – you can borrow money from a lender and ideally use that money for a specific purpose. Go to school, build a business, buy a home or car, make repairs on your home, or in some cases for an emergency situation – fix your car, medical or dental care, etc.

However, a loan should always be the last option on the table. And a loan, ideally, needs to be used for a specific purpose that will benefit you in the long run.

Why? Because A loan must be paid back with interest, which is you it’s not a trivial thing to take one out. It’s not a get out of jail free card if you don’t have money because you have to pay MORE back than you initially borrow.

Now there are different types of loans you can borrow, different credit types, and difference loan categories.’

Confusing yes?

No worries, we’ll break everything down as we go!

Loan Categories

There are two broad categories of loans which loans can be placed under: secured loans and unsecured loans.

  • Secured LoansLoans where you put down some type of collateral to back the loan. Examples of this type of loan might be small business loans, mortgage loans, personal loans, etc. The advantage is secured loans often have lower interest rates.
  • Unsecured LoansLoans where you don’t put down any collateral. The application for this type of loan is quick and you’re typically must have a high credit score to qualify. The downside is interest rates are higher.

Not all loans are equal in terms of how easy it is to get them. It’s a good idea that you familiarize yourself with what’s available, especially with regards to loans with low interest rates.

Credit Types

Before we get into the actual types of loans, there two types of credit which every loans type fall under: open-end credit and closed-end credit. Open-end credit requires small monthly payments.

  • Open End Credit: Examples of this type of credit would be credit card accounts, home equity credit lines. You can use this ‘credit’ while still making payments against the total balance.
  • Closed-end Credit: Closed-end credit are loans given with a fixed amount; these loans are always used for something specific and there is a time period attached to the loan for repayment. Examples of this type of loan would be a mortgage loan, car loan, payday loan, etc.

Before You Get a Loan

Ok, before we look at the loan types, first we should look at some facts about loans and what you can expect. Do consider the following before you take out a loan of any sort.

Most Loans Require Credit Checks

As a note before you get a loan: almost all loans require some kind of credit check, the exception being payday loans, federal student loans, or special loans backed by the government or offered by credit unions to low income households.

Bad credit will get you high interest rates on the loan or even flat denial of the loan. So it’s a good idea to look at your free credit score (either through a website or via mail order) and see where you stand. If you have bad credit, we recommend you repair your credit and if you have debt issues, seek debt counselling (which, if you tackle and start repaying your loan will help fix your credit history).

Make Sure You Can Afford to Repay the Loan

Keep in mind that being a single mother puts you in a more precarious situation when it comes to borrowing. You are likely only living on a single income: yours. This means you have less leeway when it comes to making loan payments as your single income must provide for you and your family AND be able to endure the additional loan payments that will result from taking out a loan.

If you can’t afford a loan, you can’t afford a loan. So don’t get any sort of loan that you will have problems making payments on. Absolutely look at how much interest you will pay, any associated fees for taking out a loan, the time allowed for repayment, etc.

Fully Understand the Loan Terms – interest, repayment time, penalties

Remember that loans do require you to repay them so you better read the fine print to see what you are getting yourself into.

If you end up say (for the sake of example) a loan that charges you 7% interest, you are going to have to repay 7 dollars for every 100 dollars you’ve borrowed. Some loans like credit card loans only require a minimum payment, but minimum payments are pretty much only the interest payments – you won’t reduce the principal amount by very much – if at all.

Overview of Different Loans Types

A breakdown of the various loan borrowing options are the following:

  • Payday Loans: short term loans with very high interest. These should be the loan of last resort if all other loan options have been exhausted.
  • Salary Advance Loans : get an advance on your paycheck from a credit union. Easy to get and less interest than payday loans. A good option if you have a steady income. A Payday Loan Alternative.
  • Personal Loans: secured or unsecured loans given to an individual. Can be used for anything.
  • Consolidation Loans
  • Student loans: federal and private loans used to pay for school. Usually some sort deferred interest and payment requirements until school has been completed.
  • Car Title Loans: a loan taken out based on the value of your car
  • Car Loans
  • Peer to Peer Loans: a new sort of loan where you borrow small loans from a community of lenders.
  • Home Equity Loans: loans taken out on the equity of your home.
  • Personal Loans
  • Business Loans
  • Lines of Credit

Let’s look at these in detail…

Payday Loans

Payday loans have become popular the past decade, but these have some of the highest interest rates on the market. This are also called cash advance loans or paycheck loans. If you are even thinking about a payday loan, you absolutely need to repay this type of loan as soon as possible. If you miss, say only 2 months of payments, the interest rate may actually overtake the principal amount you owe! You also will be required to pay a fee for taking out a loan on top of the high interest rates. Payday loans are useful for emergency loans – loans where you need to some quick cash for say a medical emergency or car repair. But you only take out these loans between paychecks. Keep in mind that there are a LOT of people who have declared bankruptcy because of payday loan debt. This is NOT something you want to happen to you.

If you are dead set in getting a payday loan, we absolutely recommend you read our Best Payday Loan Alternatives article to see what other short term loan options are out there with much better interest rates and lower financing fees.

Student Loans

These are loans that you can take out if you are going to school. As a single mother, you will probably want to look at federal student loans. Federal student loans are a good option for practically anyone because there is no credit check done on these type of loans. These loans are also very affordable in terms of the interest and the repayment flexibility.

You can also get private student loans which are student loans not backed by the government. Sometimes federal student loans don’t provide you with enough money to pay for your entire schooling, which means you’ll need to seek out a private student loan lender. Some of the big ones are Chase student loans and Salie Mae student loans.

Debt Consolidation Loans

These are special loans that are used to help consolidate your debt into a single account. For example, say you have multiple types of debt — different student loans, credit card debt, etc. instead of making payments on all of these loans separately, you can take out a consolidation loan to “pay off” all your single loan debts. You then make payments on the single loan. In some cases, debt consolidation loans can get you a slightly lower interest rate because it’s usually a higher loan amount. There are some pitfalls, so make sure you do your research about this topic first.

Personal Loans

A personal loan is a loan given to a person. You can use personal loans to renovate your home, go traveling, buy a car, etc. You can even use personal loans to consolidate other loan debt so you pay cheaper interest rates.

Unlike a business loan, you don’t need to come up with a business proposal and all the other paperwork associated with a business. The loan amount is usually less, however. And just like a business loan, you need to have concrete assets to help back the loan as security. Traditionally, you could get a personal loan by going to your local bank.

There are two types of personal loans, unsecured personal loans and secured personal loans.

  • Unsecured Personal Loans: This is likely the typical personal loan you will be given.  Unsecured loans are given to people on the basis of their credit score and without any sort of collateral put down against the loan. You typically need a very good credit score (or at least decent credit) to get an unsecured loan. The better your credit the lower the interest rate you will pay. It must be said that if you are looking to take out any sort of single mother loan, you are going to have to have a good credit score. Typically, unsecured loans require good credit. Some examples might be a personal unsecured loan or a private student loan. If your credit is bad, your loan choices will be a secured loan of some sort, a federal student loan (but you need to be going to school to get one), or a payday loan. As you see, there are loans for single mother available, but there is no one “loan” that you can apply for. You are going to need to examine the different type of loans and choice the best one that suites what you are trying to do (buy a home, go to school, etc).
  • Secured Personal Loans: These are loans given out based on the collateral you put down for the loan. This could be cars, jewelry, home equity, or anything that can ‘back’ the loan.

Auto / Car Loans

These are basically loans that you get to buy a car.  You can approach the bank directly and seek to get some kind of personal or auto loan to buy a vehicle. You may need to come up with a down payment to lower your interest rate or to even get the loan.

Mortgage Loans

Loans taken out to buy a home. There are different types of mortgage loans out there. We won’t delve into mortgage loans in this article. It’s a complex topic and merits an entire series of articles itself. Mortgage loans are secured loans and of the closed credit type.

Small Business Loans

Business loans are loans given out for people who want to start a business or need to money to expand a business. If you want one of these loans, you are going to need a solid, tangible idea and the assets to back up the loan. Since Business loans are secured loans, you are going to need something like another business, a house, property, or something valuable to help “float” the loan. Secured loans put less emphasis on credit history, since you are backing up the loan with your assets. However, it still does matter, just not as much.

We won’t be covering this type of loan in detail – there are entire websites and books written about how to get a business loan. Suffice to say, it’s not easy especially if you don’t have a solid income and credit history AND a solid business plan to back your idea.

Car Title Loan

You can take out a loan against the value of your car. Basically you are using your car as collateral on the loan. It’s a good way to get some quick cash that’s backed up with an asset (you don’t pay the loan back, you lose your car).

Home Equity Loans

You can use your home equity to get a loan. This is an option if you own an apartment or home – leveraging the increased value of your home equity into a loan that can be used for anything like home upgrades or repairs. Keep in mind that if your equity falls, you are in trouble.

Line of Credit

An open-end credit (also called revolving credit) where you are given access over and over to a fixed amount in your bank account. The amount you are given access to, the interest rate, and fees depend upon the line of credit you are using and if it’s secured or unsecured. The advantage of a line of credit is you can keep using it over and over (unlike a loan where you are given a fixed amount and must reapply for another one). You only pay interest on what you take out of your line of credit, not the whole amount — this is a big advantage too.

You can break lines of credit into secured and unsecured lines of credit. Secured lines of credit are backed with collateral such as your car, your house, equity, savings account, or something tangible. Unsecured lines of credit is not backed by anything.

There are three major types of lines of credit – home equity, personal, and business lines of credit. Home equity are secured by your home and can be large amounts. Personal lines of credit can be secured or unsecured. Business lines of credit are usually secured.

Popular Lines of Credit

  • Home-Equity Line of Credit: Similar to a home equity loan, but rather than taking out a fixed amount, you can keep borrowing over and over up to the value of your home equity (or whatever amount was negotiated). This can give you permanent access to a lot of money, over and over.
  • Bank Account Overdraft Line of Credit: Not really a formal type of line of credit, but it does function as one of sorts.These are a revolving type of loan of sorts that function as a line of credit. You can withdraw your bank account balance below zero, but are charged an overdraft fee and interest on the amount. It’s not usually advisable to do this as the fees can be hefty.
  • Personal Line of Credit: You can also formally apply for a personal Line of credit. This could be secured or depending on the institution and your credit history and income, unsecured.
  • Business Line of Credit: larger amounts of credit for a business. Usually secured.

Borrowing from Retirement and Life Insurance

An interesting type of loan where you essentially borrow from your own retirement or life insurance fund. It’s much easier to repay this type of loan (it’s your money). If you don’t repay this loan, however, you may face tax issues however.

Loans for Veterans

A special type of loan that’s backed by the Department of Veteran Affairs. These loans can be for a number of uses – personal, for mortgages, etc. The VA basically cosigns your loan, meaning it’s easier to get the loan, you can get lower interest rates, etc. You must of course be a veteran to qualify.

Peer to Peer Loans

This is an altogether new loan system that’s come out of the web 2.0 age. Basically, you can borrow from the ‘crowd’. It’s easier to get approved for small loans and the interest rates are usually better. These function as personal loans of sort, but usually with less restrictions and lower interest attached than you would find from a bank. If a bank denies you’re a personal loan, then looking into Peer to Peer loans is a recommended alternative, though you still may pay more interest if your credit is bad and you are deemed high risk, so there is no guarantee you can get a Peer to Peer loan if a bank denies you a loan first.

Cash Advances

These are usually given out by credit card companies by taking out cash on your credit card. It’s also possible to get cash advances taken out from your income tax return by some companies. The downside is cash advances are not tax deductible, the amounts are small, and there’s often a high interest rate associated with it. Payday Loans are a type of cash advance, but we’ll put them in a separate category.

Salary Advance Loans

Some banks or credit unions do offer special short term type loan where an advancement against your paycheck is given. There are different requirements depending on the bank you are lending from. There are better alternatives to payday loans, but typically you need to have direct deposit for your paychecks already set up and a history of payments into your account.

Specialty Loans for Low Income Households

These are special loans that are offered as financial assistance to low income households. They are usually backed by a government initiative. Lower credit scores (or no credit checks) are allowed and they are usually unsecured loans. In some cases, these loans have no interest (charity loans for financial assistance).