Loans are intrinsically likened to a tool or instrument that helps one plan a financially savvy life. For different needs, there are different loan types. From building your home to the purchase of your first luxury car there is all sort of loans. A lot of people don’t know but even credit cards fall under the umbrella of loans. Due to myriad loan categories with different interest rates, terms, and condition; it becomes overwhelming to shop around.

Thus, to ease off your burden, Faircent presents the most comprehensive yet simplified guide on – All the Major Types of Loans in the Financial World; their purpose, features, and usefulness in meeting consumer capital needs.

Mortgage Loans – Beyond Just Financing Home

For word-nerds, it is easy to comprehend the sinister roots of the word “Mortgage”. It has an Old French Origination - 'mort’ meaning 'death and ‘gage’ meaning “pledge”. Thus, if you connect the dots right, it is thought-provoking to recognize – “In a Mortgage Agreement, unknowingly a “pledge” is made to fully pay-off the debt till the day the borrower dies”. Phonetically, the word ‘debt’ and ‘dead’ also sound similar. Thus, it literally means the 'death pledge’!

People often confuse a Mortgage loan with a Home loan, however, these two are poles apart. Funds acquired through a mortgage loan can be utilized for varied purposes. Mortgages are not just about buying a home on a death pledge but to make your home acquisition process easier.

 

 

 Mortgage Loan

A loan where some property or real-estate is the collateral is Mortgage Loan. To avail funds from any financial institutions, you are supposed to provide a collateral. The collateral in case of Mortgage loan could be any valuable asset including real estate, residential property, non-agricultural land, commercial shop etc. Thus, it is a secured loan that has three basic principle elements – principle, rate, and term. By playing safe around these three elements you can avail the best Mortgage loan.

Popular Mortgage Loan Types

Fixed rate mortgage (FRM)

Colloquially termed as “Vanilla Wafer Mortgage”, the Fixed Rate Mortgages are available for the home finance seekers ever since the origination of the lending institution. In the world of fluctuating economies, the FRMs bring peace of mind for homeowners by fully amortizing loan with a fixed rate during the entire loan life. The amortization structure follows a monthly payout plan, which makes budgeting consistent for the homeowners. By extending the payoff period the monthly payments decrease. FRM loans can be categorized under the following three types –

40 years Fixed – It has the longest tenure and lowest interest rate. It is the best option for residential property owners who want low monthly EMIs. On the downside, you build equity more slowly and pay more on the interest in the longer run.  

30 years Fixed – It is less costly in long run in comparison to 40 years FRM. The borrower pays a predictable and fixed EMI for a tenure of thirty years.

15 years Fixed – With a 15-year mortgage you pay-off your mortgage in half the time. Thus, putting you on fast-track towards completing loan amortization. Even the monthly pay-offs are higher, it builds up your equity in long run.

Adjustable Rate Mortgage (ARM):

It is also known as Floating Rate Mortgage. In this type of Mortgage loan, the interest rates are low and fixed during the introductory period, however, not throughout the entire loan term. The rates can rise, and fall based on the credit market index such as Prime rate, Cost of Fund Index, LIBOR or other market indexes.  Borrower’s monthly payment may change dramatically as the interest rates rise or fall in relation to the fluctuations in the credit market index.

Jumbo Loans – Save Big on Luxury Home Purchase

Also known as Non-Conforming Mortgage loan, it is a form of home financing, for whose principal balance i.e. “Conforming” loan limit exceeds funding criterion as set by Fannie Mae and Freddie Mac, which form part of the US Federal Housing Finance Agency.

Jumbo loans are designed towards making the purchase of high-end luxury properties such as vacation homes, top-of-the-line fitness, spa center and investment property types easier. Both fixed and adjustable rates are available for these non-conforming mortgage loans.

Characteristics

1. Best suited to high-income earners who have a good credit history.

2. Interest rates are competitive in comparison to regular home loans

3. Your credit limit remains unblocked

4. You must have a lower debt-to-income ratio

5. Stricter underwriting cost and larger down payment

Balloon Mortgage

It is a type of Mortgage loan in which payments are not completely amortized over the life of the loan. When a borrower applies for a Mortgage loan with “Balloon payment”, during the origination of loan the payments are low and fixed; a borrower may only pay the interest rates for a certain time period – 5 years or 7 years; however, at the time of loan maturity the loan requires a large sum of money that may be equivalent to full principal in order to close the loan. Since the closure amount is large, it is called a Balloon Mortgage loan.

HELOC

HELOC stands for Home Equity Line of Credit – It a convenient way of borrowing by utilizing the market value of home i.e. home’s equity as collateral.

How HELOC works?

It works like a business line of credit or a credit card; where you withdraw money as per your discretion, and only pay back the amount that is withdrawn. Borrowers get pre-approved spending limit, depending upon the credit score and income. The draw period can be typically 5 to 25 years; during which monthly payments must be made.

HELOC Interest Rates

Most HELOCs have variable rates and the interest payments are tax deductible. These are predetermined and may fluctuate based on the prevailing financial index; typically, the Prime Rate. You can flexibly utilize HELOC to pay off your bills, credit card debts, school tuition or make any home improvement.

Unsecured Loans – Fulfil your Short-term Finances

Also known as personal loans or signature loans, unsecured loans are the best short-term finance option. These loans are given strictly contingent on the borrower’s credit-worthiness; without pledging any asset as collateral. The eligibility is gauged in terms of Credit score (CIBIL score), financial standing and monthly income.

You can apply for a personal loan with banks, NBFCs, credit unions and other similar financial institutions.  In case of defaults, bankruptcy or liquidation; there is no asset to seize; thus, these kinds of financing cater more risk to the lenders. Therefore, interest rates charged are considerably higher in comparison to secured loans (loans protected against collateral); while interest rates differ from one financial institution to other.   

Unsecured loans are highly flexible; borrower can use the loan amount for varied purposes. It is a multi-purpose loan that a borrower can utilize for supporting business expenses, debt consolidation, wedding planning, to make a major purchase or just to go on a vacation. Such flexibility from unsecured loans makes them a preferred choice when unforeseen emergencies arise.

Special Types of Unsecured Loans

Payday/salary loans

A payday loan is also called a salary loan or a cash advance loan. It is a short-term, high-interest-rate loan that is typically unsecured in nature; to meet unexpected expenses. The borrower’s eligibility is checked based on the employment records and credit score. The repayment of the loan is linked to the borrower’s payday. The borrower writes the check for the loan amount along with the fees. The lending partner encashes the check once the borrower is in the position to repay it. Hence, the name Payday loan.

Credit Card

A credit card is a financial tool i.e. essentially a payment card. The banks or credit institutions set a credit limit for the borrower that allow access to cash advance like a revolving account. The borrower can tap in for credit anytime and reuse the line of credit repeatedly. The borrowing limit is predetermined depending upon the individual credit rating.

Business LOC

Business Line of Credit is a financial instrument that is similar to a Revolving account. A borrower can any time avail quick funds; in the form of a short-term Business Loan and pay it back and spend it again and again, in the form of revolving cycle. It helps a business to meet short-term monetary needs. No interest rates are charged until funds are tapped into.

Credit Derivatives

A credit derivative is a financial instrument that offers users (private investors or governments) a flexible way of managing exposure to credit risk such as bankruptcy. For example, banks utilize credit derivatives against loan default to protect themselves against loss. They shift the credit risk on the shoulders of a third party while the loans remain in their books. Credit derivatives can be broadly categorized into two types – Unfunded Credit derivatives and Funded credit derivatives.

Special Types of Credit Derivatives

Credit Default Swaps (CDS): It is a financial swap that belongs to the category Unfunded credit derivative. This type of swap is designed to transfer credit risk exposure to fixed income products such as municipal bonds, emerging market bonds or corporate bonds.

Asset-backed security: Also called ABS, these are pools of loans that are bundled and traded as securities and have home mortgages, auto loans, home equity loans, student loans etc. as underlying securities.

Mortgage Backed Security (MBS): It is also a type of ‘asset-backed security’ that is secured by mortgage as a collateral.

Bonds – You are the Lender

Bond is a fixed income investment, in which an investor loans funds to an entity or organization (generally corporate or government) to finance the latter’s business plans. The main purpose of bonds is to raise capital by borrowing; e.g. Government bonds are debt instrument useful to finance the expenses of the government. The authorized issuer (indebt entity) is obliged to pay interest (coupon rate) at fixed intervals and entire bond principal at the time of maturity.

Features of Bonds

Types of Bonds based on Maturity Dates

Bonds have predefined set maturity dates. They can range from 1 to 30 years — On the basis of the bond maturity date, these can be of three types - short-term bonds (mature in 5 years or less), intermediate bonds (mature in 6-12 years) and long-term bonds (mature in 12 years or more).

Types of Bonds based on Interest Payments

Fixed Rate Bonds (coupon rate remains constant throughout the loan life), Floating Rate Bonds (have variable coupon payments that are periodically adjusted linked to a reference rate of interest, such as Libor or Euribor), Zero Coupon Bonds (do not pay regular interest but are offered at a discounted price in comparison to par value and can be redeemed at the par value at maturity date) and Callable Bonds (Bonds with "call feature", allow the issuers to redeem the bonds before their maturity date, pay back the principal and thus, limiting interest payments).

Credit Ratings

It is an essential factor to evaluate the "default risk" of a bond. Two world’s leading credit rating providers for bonds are Moody's Investors Service and Standard and Poor’s. Credit ratings by these two agencies are closely watched by the investors worldwide. Moody's ratings go from AAA, which is the highest-grade, to the lowest risk grade C for the bonds that are in default with negligible chance of the principal being repaid. Likewise, Standard & Poor's (S&P) is the world's foremost source of ‘independent’ credit ratings of bonds.

Principal Investment Repayment

The indebt entity is obligated to pay back the complete principal amount when the bond reaches maturity date.

Stafford loan

The Stafford Loans are the most popular low-cost, fixed interest rate student loan insured by the U.S. Department of Education as your lender. The Stafford Student Loans are offered to eligible undergraduate and graduate students to finance the educational expenses.

These are the most affordable and safe student loans under Federal Government regulation to help eligible students join a reputed college or university.

Types of Stafford Loans

There are two basic types of Stafford Student Loan; Subsidized and Unsubsidized Stafford Loan. The loan repayment tenure is although quite flexible. The federal government pays the interest when you are in school at least half-time. The main difference between the two is –

In case of subsidized Stafford loan – for a selective period the Federal government pays the interest rates on your behalf.

In the case of unsubsidized Stafford loans – Student is accountable for all the accrued interest rates while in school, during the 6 months grace period and similarly during periods of deferment.

You are eligible for a Stafford Student Loan if you are a U.S. citizen, national, or eligible non-citizen and have a standard high school diploma (e.g., GED) or enrolled at least half the time with school or university that partakes in the Direct loan Program. No credit check, principal payment or cosigner is compulsory to apply for this type of loan.

 Deferment of Payment

A student may be eligible for the loan deferment under emergency circumstances e.g. health issues. Even after leaving school for six months you can enjoy the grace period after which you can start paying back the loan.

To apply for it online visit department of education website and submit the FAFSA form (Free Application for Federal Student Aid). It will help you determine the amount of education aid you are eligible to receive.

Means of Getting Loans

Applying for a Personal Loan is not as complicated as it seems. It is essential to pay attention to providing all the genuine documents to be submitted to the financial institution you choose. Every type of loan application calls for a specific type of documentation. Other than customary lenders such as banks there are other means of getting credit –

Banks - A bank is a licensed financial institution that undertakes public deposits and ordains lending activities. Numerous financial services are also provided by banks such as personal banking, wealth management, foreign exchange trading, money market trading, currency exchange, and safe deposit boxes.

P2P lending – Peer to Peer Lending Platforms offer a virtual credit marketplace that allows creditworthy borrowers to borrow directly from the community of lenders or investors. It is a pioneering approach where borrowers and lenders can interact directly; thus, cutting the traditional intermediation - banks and NBFCs from the process.

NBFC – It stands for the Non-banking financial company; that offers a plethora of financial services such as personal loans and short-term finance, retirement plans, underwriting, and merger undertakings; but do not have a banking license.

Pawn shops – A Pawnshop or pawnbroker offers secured loans to individuals, with elements of individual’s property pawned to the broker as collateral. Items that can be pawned includes jewelry, musical instruments, televisions, power tools, or any other valuable assets.