Although there are literally hundreds of different kinds of loans, all loans have certain things in common. Before you can figure out what kind of loan you need, you should have a firm grasp on the basics of borrowing money.
No matter how big, complex, or intricate the rule of a loan are, there are always three main components to a loan.
Security
The security of the borrowing process simply means “are you securing your loan?”
A secured loan means that you have put up collateral to the lender. In the case of a loan default, the lender will take possession of your property. Car and home loans are secured loans, as the borrowed funds have been “secured” by your physical assets.
Unsecured loans require no collateral. Student loans and personal loans are the best examples of unsecured borrowing. Due to a greater risk of financial loss for the lender, unsecured loans have higher interest rates.
Term
How long are you borrowing the money for? What is the maximum amount of time before you have to be fully paid off? How much wiggle room do you have in either direction?
Simply put, the term is the length of time you have to pay back the money.
But some loans are structured so that you cannot pay them early without penalty. Other loans encourage you to pay them off as quickly as possible. So when you decide on the term, find out how set in stone it is.
Interest
This is the part of borrowing most people focus on, but it is really just one factor.
The interest or APR is the amount of money you will be charged for the loan. It is a percentage of the amount borrowed, but that percentage is determined by many factors. The security and term of the loan, as well as the kind of borrowing (fixed rate interest or adjustable) all play a factor in determining the interest rate.
At it’s most basic form, a loan is the Amount Borrowed multiplied by the Term and the Interest.