The Different Types of Loans Available & Their Associated Interest

The Different Types of Loans Available & Their Associated Interest Rates

There are several different types of loans, and each is best for certain financial situations. Compare your options before you apply to make sure youre getting the right loan for your needs.

A secured loan is backed by collateral, such as your home, car or other property. If you default on the loan, your lender can repossess the asset to get their money back. Unsecured loans, such as credit cards and personal loans, do not have collateral.
Fixed-Rate Loans vs. Adjustable-Rate Loans

The Different Types of Loans Available & Their Associated Interest Rates
Fixed-rate loans offer borrowers the most predictable monthly payment. They are also easy to budget and plan for, so theyre a popular choice for homeowners who have stable but tight finances.

An ARM, on the other hand, changes its interest rate periodically as market rates fluctuate. There are many ARM types, but the most common is the 5/1 adjustable-rate mortgage, which locks in your interest rate for five years and then adjusts once a year for the remainder of the loan.

These types of loans often come with caps that limit how much your interest rate can increase over time. These caps may include an initial cap, which limits how much the introductory rate can initially change; a periodic cap, which limits how much your introductory rate can increase from one adjustment period to the next; and a lifetime cap, which prevents your ARMs interest rate from rising above the introductory rate over the life of the loan.
Fixed-Rate Mortgages

Unlike adjustable-rate mortgages, fixed-rate mortgages lock in your interest rate for the life of the loan. This allows you to create an amortization schedule with constant monthly payments, which helps you budget more easily.

Depending on your credit history, you may be able to qualify for a fixed-rate mortgage. The interest rate on a fixed-rate mortgage is generally lower than on an adjustable-rate mortgage, but you should check to make sure youre getting the best rate available.

If youre planning to stay in your home for several years, a fixed-rate mortgage is the way to go. A fixed-rate mortgage is also a great option if you anticipate your income growing over the long term.

ARMs, on the other hand, are designed to adjust as market interest rates change over time. The first few years of an ARM often feature a lower introductory rate, which is typically tied to an index.
Adjustable-Rate Mortgages

Adjustable-rate mortgages (ARMs) offer a lower initial interest rate for a certain period, then change as market rates rise or fall. They’re popular with borrowers who expect to sell their home within a few years or those who want to make additional principal payments in order to pay off the loan more quickly.

ARMs typically come with introductory interest rates that last for five, seven, or 10 years, depending on the lender. These rates are typically lower than the fixed rate you’d get with a comparable FRM, and they can be quite affordable.

However, ARMs aren’t a good choice for long-term homeowners. If you plan on staying in your home for a decade, you’re going to want a fixed-rate mortgage.
Variable-Rate Mortgages

The Different Types of Loans Available & Their Associated Interest Rates
One of the most popular mortgage options is the variable-rate mortgage. These are typically the most affordable type of mortgage, but youll need to decide whether the benefits outweigh the risk.

Variable-rate mortgages are linked to a standard index, such as the Euribor or the IRPH, plus a margin that is set at the lenders discretion. This means that if the index moves up, your rate will go up too.

However, these types of mortgages arent immune to mistakes that can cost borrowers a lot of money. In fact, a study published in December 1995 revealed that 50-60% of adjustable-rate mortgages contained errors that caused homeowners to pay interest rates that were more than US$8 billion higher than they should have paid.

In order to avoid these pitfalls, its important to understand how an ARM works and what the interest rate benchmark is in your contract.

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