Loan Basics — Understanding Loans and Lending

Understanding Loans and Lending

Most of us experience times in our lives when we want or need to have access to larger sums of money. Paying for college, purchasing a car, starting a business, or consolidating debt are all life events that may require getting a loan.

Taking out a loan is a commitment—you’re agreeing to pay the money back within a certain period of time—and you need to be prepared.

Banks and other lenders have certain lending guidelines and qualifications that borrowers need to meet in order to be approved for a loan. It’s important to do your homework to understand the types of loans that are available and know what lenders are looking for so that you can improve your chances of finding the right loan to fit your needs—and get your loan approved.

Loan types

Learning the differences between the various types of loans can help you evaluate your lending needs and weigh your options—you’ll have a better understanding of which loan will best suit your needs and how to evaluate the terms offered by various lenders.

There are many different types of consumer loans. Some of the most common include:

  • Fixed-rate loans: Most consumer loans are fixed-rate loans. Fixed-rate loans keep the same interest rate throughout the life of the loan.
       
  • Variable-rate loans: The interest rate on variable-rate (or “adjustable-rate”) loans moves up and down based on the changes of an underlying interest rate index (usually the prime rate). Interest rates on these loans usually have caps or limits on how high it can move in a given period, but the rate can change multiple times during a year. The interest rate on a variable-rate loan may initially be lower than a fixed-rate loan, but it could move higher over time.
  • Installment loans: A loan that is repaid over time with a set number of scheduled payments. The term of loan may be as little as a few months and as long as 30 years. A mortgage, for example, may be considered a type of installment loan.   
  • Secured loans: These loans are backed up by a large asset as collateral, which would be forfeited if the loan is not repaid. A home equity loan is an example of a secured loan and your house would serve as the collateral. If the loan is not repaid, the lender would be entitled to take the house.   
  • Unsecured loans: These loans do not require any collateral and are generally only given to borrowers with very high credit scores. The interest rates for unsecured loans are often very high.
  • Convertible loans: These are loans that can be changed from one loan type to another—from a fixed to a variable rate and vice versa. One of the most common types of convertible loans is an adjustable (variable) rate mortgage that can be converted to a fixed rate loan.

What to look for in a loan (and what to ask potential lenders)

Your goal is to get the best rate and terms on the loan that best fits your needs. It takes some effort—you'll need to shop around and request loan quotes from multiple lenders.

Loan quotes feature an estimated interest rate, loan term and fees. Compare the offers and choose the loan with the lowest rate possible with monthly payments you can afford.

Interest rates

  • Ask lenders for a list of current interest rates. 
  • Ask about the APR (annual percentage rate). APR takes into account interest rate and points, fees and other charges, expressed as a yearly rate.   
  • Find out whether the rate is fixed or adjustable. If the rate is adjustable, ask how your rate and loan payment will vary, and whether your loan payment will be reduced when rates go down.

Points

Points are fees paid to the mortgage lender or broker, and are often linked to the interest rate. A “point” is one percent of the total loan amount.

  • Check your local paper for information about rates and points currently being offered.   
  • Ask for points to be quoted to you as a dollar amount, rather than just as the number of points, so you’ll know how much you have to pay.

Fees

Home loans involve many fees, such as loan origination fees, broker fees, and transaction, settlement, and closing costs. Every lender or broker should be able to give you an estimate of its fees.

  • Ask what each fee includes.   
  • Ask for an explanation of any fee you do not understand.

Tip: You may want to consider getting pre-approved for a loan before you find the home or car you’d like to purchase. This way, you will know exactly how much you can afford to spend, and the process can go more smoothly.


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    This site is for education purposes. The material provided on this site is not intended to provide legal, investment, or financial advice or to indicate the availability or suitability of any Capital One product or service to your unique circumstances. For specific advice about your unique circumstances, you may wish to consult a qualified professional.