Installment, Secured, and Unsecured Loans
All loans are alike in some ways. You borrow an amount of money, called the principal, for a set amount of time, called the term, at a fixed interest rate or a variable rate. Some loans require the principal to be repaid all at once. Others, called installment loans, require regular payments of a specified amount at predetermined intervals, usually every month.
Secured and Unsecured Installment Loans
Loans can be secured or unsecured, which refers to whether or not they are backed up by collateral. For example, car loans and mortgages are secured loans. Your promise to repay the loan is secured by the car or house you're buying. If you fail to make your payments, the lender can seize the car or house to recoup the money it lent you. Unsecured loans are backed up only by your promise to repay.
Most people use installment loans when buying a car or boat. Sales contracts are a type of installment loan commonly used when purchasing appliances or furniture. The retailer provides financing or outsources it to a finance company and you make monthly payments, including interest, until the balance is paid.
Revolving credit is more flexible than an installment loan. There's a maximum you can borrow, and a minimum you must pay each month, but the rest is up to you. Personal lines of credit are a type of revolving credit account where you qualify for a certain amount and use it at your own discretion by writing special checks provided by the lender. Lines of credit are great if you're not sure when you're going to need the money and want to have funds available quickly. Many people use home equity lines of credit to make improvements to their home or pay down credit card debt.
Department stores often offer revolving credit loans with no interest and no payments due for three to six months on large purchases such as furniture or appliances. If you take advantage of these offers, be sure to pay the entire balance before the interest kicks in. Often these accounts are turned over to a finance company at the end of the interest-free period, and the interest rates are high. Although no payments are required for several months, it's a good idea to make them anyway, or put money aside each month to pay off the balance at the end of the interest-free period, so you'll be sure to have the money available. Otherwise, these are not such great deals, because your purchase ends up costing you considerably more when you factor in the interest.
Don't waste your money buying any of the various types of credit insurance from credit card or finance companies. Credit life insurance pays the balance on a loan if you die. Credit property insurance covers damage to the item that's being purchased with the loan proceeds. Credit disability insurance makes your loan payments if you're disabled, and involuntary loss of income insurance makes your loan payments if you're involuntarily unemployed.
Try to avoid using your home as collateral on any loan other than your mortgage. You could lose it if you're unable to make your payments, so unless you are financially disciplined and are in control of your spending, be very cautious.
You'll be offered one or more of these coverages when you buy a car. Some dealers add them in without telling you. They earn a commission from the insurance company for selling the insurance and they get the interest on the insurance premium when they fold it into your loan. Insurance that's tied to one particular debt is an expensive way to insure yourself against losses. If something does happen, only the payments for that particular item are covered. If you feel insurance is necessary, talk to your insurance agent about a broader policy, such as disability insurance that would replace your income if you became disabled or life insurance that would provide a lump sum to your beneficiary instead of to the lender.