All bank loans are either secured or unsecured no matter what they are. There are numerous types of bank loans, each bearing their own purpose. It is useful to know the differences in order to better understand how bank loans work and what is expected when applying for one either as a business or individual. Herein is a brief but comprehensive overview identifying and explaining the different types of bank loans.
A secured loan refers to a loan that relies on an asset, such as the vehicle or real estate property, as collateral for the loan. The bank can take possession of the asset (repossess a car or foreclose a home) in the event that the borrower fails to pay the loan. The bank can sell the asset to recover the sum of money loaned.
As such, the interest rates on secured loans are usually lower than those exhibited in unsecured loans. In many instances, such as in the purchase of real estate, the asset to be set as the collateral has to be appraised before the terms of the bank loan can be set. Examples of the secured loans include car, boat, construction and home equity loans as well as mortgages.
Unsecured loans do not require the borrower to set forth an asset as collateral. The bank, in this case, relies solely on a borrower’s credit history and income as well the credit history as qualification criteria for the loan. The bank has to try and collect the unpaid balance through various means in case the borrower defaults. These can include freezing accounts, lawsuits, garnishing wages and collection agencies.
Due to the significantly higher assumption of risk on the bank’s end with unsecured loans, the interest rates are often much higher as compared to secured loans. It is much more difficult to obtain unsecured bank loans and the amounts loaned are lower than for secured loans. Examples of the unsecured loans are such as personal loans, student loans, credit cards or department store cards.
Mortgages are among the most complicated types of bank loans and generally have the most variations, the first being who is guaranteeing or underwriting the loan. They have mostly secured bank loans but can also be unsecured, albeit much harder to obtain. On the basic level, a mortgage is a debt structure, secured by specified real estate property collateral that a borrower is obliged to repay under a predetermined set of payments.
They are utilized by businesses or individuals to purchase real estate without paying the full amount of the purchase up front. The borrower repays the loan and interest over a time period until sufficient to own the property. They are also referred to as claims on property or liens against the property. The various types of mortgage bank loans include:
- Fixed rate mortgages – In a fixed rate mortgage, the interest rate remains constant throughout the term of the loan. The borrower makes a set payment, often monthly, for a predetermined number of years until the loan is paid off.
The payments usually are amortized. This means that as time goes by, more of the set payment is applied to the principal than to the interest. The most common types of fixed-rate mortgages are 15 year and 30-year mortgages.
- Adjustable rate mortgages – An ARM is one where the interest rate fluctuates. It can increase or decrease annually, semi-annually or monthly. It is crucial to note how the rate can adjust as well as the margins and index used to set new rates with any ARM.
- Interest only mortgages – Interest-only mortgages have an option of making an interest-only payment. This option is available for a certain period of time. However, there are some mortgages that are fully interest-only. Interest-only mortgages are less common and are recommendable only to sophisticated borrowers.
There are other types of bank loans most of which are less common and new on the scene including but not limited to balloon mortgages, reverse mortgages, debt consolidation, interim, installment, and inventory and payday loans.