What Are Loans?

Loans refer to when one party gives money to another on the condition that it be paid back, typically with interest, at a certain time in the future. The terms of the loan determine what that interest rate will be, how long the borrower has to repay the money, and sometimes place additional stipulations on the funds including how the proceeds are used.

Loan Purposes

Loans can be issued for any purpose. Sometimes, people borrow to invest in something (or themselves) such as loan to start a business, buy a house or go to school. Other loans may cover personal expenses that come up in life, such as medical expenses, a new car or even a vacation. However, just because you can borrow for any purpose doesn't mean it's a good idea.

Interest Rates

The interest rate can be either fixed, meaning it stays constant for the term of the loan, or variable, meaning it can change over time. Interest rates are generally lower if you have a good credit score and if your loan is secured by valuable collateral, such as a house, according to the Minneapolis Federal Reserve, because the lender has a lower risk of losing the money it lends you. If you have a hard time qualifying for a loan on your own, a cosigner may help you get approved or get you a lower interest rate. However, a cosigner is liable for anything the primary borrower doesn't pay, so if asked to cosign for a friend of family member, you might tread cautiously unless you are comfortable paying back the entire loan.

Repayment Schedule

Loan terms also include a repayment schedule, which tells you when and how much you have to pay. Some loans have monthly payments for a certain number of years until you pay off the debt. Others, known as balloon loans, may let you make smaller payments, such as just paying the interest, and then require a lump sum payment at the end of the term. If you're looking to get out of debt faster, some loans allow you to pay them off ahead of schedule with no downside. However, others impose a penalty for prepaying the loan that can reduce or eliminate any interest you might save by paying early. Check with your lender before making additional payments.

Tracking Your Loans

If you owe money on a loan, making each payment on time helps you avoid additional interest charges and costly penalties. In addition, on-time payments increase your credit score, which can help you get lower interest rates in the future. Consider using software like Quicken to stay on top of your loan payments so you can get out of debt faster.

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