Although the economy is at a standstill (or moving backwards, some say) many Americans can still get loans when they need them. With regards to consumer (non-business related) loans, most fall into two categories; secured and unsecured.
Many say American consumerism and the need for instant gratification is at least partly to blame for the downturn of the American economy over the last couple of years. Buyers were too willing to borrow or bring out the credit card when faced with a purchase decision. Banks made loans to people who simply could not afford the terms. The government and the banks are pointing their fingers at each other when asked who is to blame.
For this reason, banks are reluctant to make loans. Word in the press is that loans are hard to get, and personal loans even harder. But there is still money in the economy to be loaned to people who need it and the growing consensus is that lending institutions need to make sure the money is loaned to people who need it who can also pay it back. But American consumers need to be honest about their situations when considering a purchase made with debt.
Secured Loans A secured loan is the most desirable from the lending institution's standpoint because there is collateral associated with the loan. The collateral is roughly equal to the loan being made, and the bank has a guarantee of value if the borrower defaults on the loan. Collateral can be real estate, a home, a CD, or a vehicle, in the case of an automobile loan. If the loan defaults, the bank takes ownership and sells it to re-coup some of its losses.
A mortgage is usually the most prevalent type of secured loan. The homes value at the time of purchase is the determining factor for how much the bank is willing to loan a buyer. The loan is amortized over a number of years, usually 30, but some buyers are financing for 15 years in order to get a better interest rate. (Use a mortgage calculator to see the difference.) Over the course of 30 years, the buyer will pay interest greater than the original purchase price of the home. The 15-year mortgage option, while one paper looks like a great savings, can put a homebuyer in a bad situation if unforeseen circumstances like job loss or divorce occur.
An automobile loan is another type of secured loan with which many consumers are familiar. The value of the automobile is used as the collateral. Banks generally put more limitations and stipulations on the loan along with higher interest rates than a mortgage because the value of the automobile depreciates as the car ages and because the loans are paid off much more quickly. Most new car loans are made for five or six years. Other types of loans in this category could include motorcycles, boats and RVs since the bank will make the loan based upon the value of the purchase.
A home equity loan does not use the home as collateral per se, but is based upon the value of the home versus what the borrower owes on the home, or equity. For example, if the borrower has a home worth $200,000 and owes $175,000 on the principle, she has $25,000 in equity. A bank or credit union can feel comfortable making a loan based upon that amount. This type of loan is sometimes called a second mortgage, and generally has much lower interest rates than a personal loan. Common uses for home equity loans are home improvements, other property or college education.
Unsecured Loans No collateral is required to get an unsecured loan. For this reason, the interest or fees charged to the consumer is typically higher than that of a secured loan. Historically, lending institutions offered unsecured or personal loans only to their best customers. These loans might also be known as signature loans because the only guarantee the borrower had to have was his reputation. His signature on the loan agreement was his promise to repay the debt.
Credit card debt is a type of unsecured loan that has skyrocketed over the years. Historically, banks only offered credit cards to it very best customers, and charged them for the convenience. These days, the average consumer has several different credit cards and carries more debt than he should. Besides major credit cards, a consumer can have gas card or store credit cards. Even internet businesses like amazon and ebay offer credit cards. Christmas gifts, vacations and back to school are typical seasonal credit card purchases. Department stores used to offer layaway programs, but in this time of instant gratification layaway as we know it has ceased to exist. As interest rates were lowered, many consumers demanded the credit made available to blue-chip customers. Currently the average American has five credit cards.
Student loans are another type of unsecured loan, and are historically notorious for their default rate. The advantage of a student loan is deferred payment; the borrower doesnt have to pay until six months after she completes school or discontinues full-time education. The payment schedule is usually spread out, too, over 10 years time, and can once again be deferred if the borrower decides to enroll in a masters or doctoral program.
For emergency purposes, payday loans can be obtained in many states. Called payday loans because the whole amount is due on the borrowers next payday, the lender charges a fee to make the loan. Most banks will not make this type of short-term loan because the amount person wants to borrow is so small, generally less than $500. A bank would not make very much money using its business model on this type of loan. The fee associated with this short-term loan is sometimes much more favorable than bank overdraft fees, bounced check fees or utility shut-offs.
The Future of Consumer Loans Most unsecured loans are used for higher end purchases that a person could not otherwise make if not for the credit extended. Personal loans may be sought out for medical expenses or for a new washer and dryer when something breaks down.
Even with the questionable economy, and with banks reluctant to make loans even to people with less than stellar credit, consumers still have the option of using credit to make purchases. Each buyer must way the options of interest rates and fees versus the convenience of having the items right now. Many consumers get themselves into financial hardship because they cant control spending. For those who use it with discretion, borrowing money to make purchases is a viable option when faced with large purchase.
Unfortunately, economists are not sure exactly what has to happen in order to help the economy. Most agree that Americans have to buy stuff. But with the economy down for so long, with investment value dwindling, with unemployment prevalent, American consumers just arent willing to spend money, which means more unemployment because companies will not have to manufacture new items. The government urges self-reliance, but has spent our next two generations into a debt they may not be able to pay off while trying to bail out entire industries and jumpstart the economy. The American consumer and the American lending institutions have learned a great lesson. The result will be higher interest rates on unsecured debt, and a general tightening of the belt when it comes to spending.
