A Little Lesson on Loans

The opportunity to spend money is everywhere. There is no shortage of places that will take your cash. In fact, to keep the money flowing out of your wallet, banks and merchants continually come up with easier ways for you to spend it.

But when it comes to borrowing money, suddenly the cash pipeline doesn't operate so smoothly. Money becomes a more complex issue with documents and terminology that practically require you to have both an MBA and Law degree to fully understand.

Before you get dazed by the paperwork and lost in the legalese of loan products, here is a quick lesson on loans.

1) The Basics
When you get a loan, you are borrowing money with a promise to pay back the original amount (principal) plus an extra amount as a fee (interest) for the privilege of borrowing. The amount you pay in interest is normally a percentage of the loan amount -- the interest rate.

Example: If you borrow $100 with an interest rate of 10%, you will pay back $110. That consists of the $100 principal plus $10 interest.

2) Loan Categories
From a broad perspective, loans fall under one of two categories: a) Installment loans and b) Revolving Credit loans.

a) Installment loan: The installment loan is probably what most people think of when talking about a loan. Money is borrowed from the bank in one lump sum and normally paid back in installments, or increments, over a set period of time. The sum paid back can include both the principal plus interest or the payments may contain interest only with the principal being paid all at once in the last loan installment, known as a balloon payment.

Loans that fall under this category include mortgages, personal loans, and auto loans.

b) Revolving Credit loan: Revolving Credit (also called Revolving Line of Credit or Credit Line) is a loan where a lender allows someone to borrow money up to a specific limit, called the credit limit, whenever money is needed. The borrower draws down the credit limit every time an amount is borrowed. The borrower can use as much of the credit as he or she wants. When a repayment is made, the available credit rises by the paid amount.

Example: Borrower gets a credit limit of $1000. $100 of the credit is used to buy merchandise. The credit limit now decreases by $100 to $900. A day later, the borrower decides to borrow another $100 decreasing the credit limit to $800. Next month, borrower pays back the $200 plus interest and the credit limit goes back to the full $1000.

Loans that fall under this category include credit cards, home equity line of credit (HELOC), and business lines of credit.

3) Rates
As you already learned, the interest that you pay is calculated as a percentage of the principal amount. Some loans have a fixed interest rate while others have an adjustable rate of interest.

A loan with a fixed interest rate means that the interest you pay stays the same throughout the life of the loan.

The adjustable rate loan, on the other hand, has an interest rate that can fluctuate from period to period. That means a borrower can expect to pay more or less interest as the rate fluctuates. The rate's movement is tied to indexes that track a basket of interest bearing investments. As the interest rates of the index moves up or down, the interest rate on your loan is adjusted accordingly.

There you have it. You just completed your lesson on loans. Now that you have a grasp of the basics of loans, you will be better prepared to understand the minute details of the loan that you need.

Jon Galanty is a financial writer for eMoneyCentral.com. Visit http://www.emoneycentral.com to find out more about loans and to get other great money tips.

Wall Street Journal Blogs

December 22 Is Deadline to Apply for SBA Economic Injury Disaster ... MarketWatch - 14 hours ago The deadline to file applications for Economic Injury Disaster Loans (EIDLs) is December 22, 2008. Small businesses and small agricultural cooperatives that ... Small business loans dwindle The Tennessean Loans available for September storm damage Columbia Missourian Wells Fargo named top small-business lender in Texas Bizjournals.com Marshall County Journal - Salt Lake Tribune all 264 news articles

Democrats support FDIC loan plan The Associated Press - Nov 18, 2008 He cited a program the government announced last week in which borrowers with loans owned or guaranteed by mortgage giants Fannie Mae and Freddie Mac would ... Hiccups appear in bank loans Burnet Bulletin CORRECT: Modified mortgages often re-default MarketWatch Loan Modifications For Banks Could Mask Future Losses CNNMoney.com Bristol Press - New York Times all 1,026 news articles

FHA-Backed Loans: The New Subprime BusinessWeek - 4 hours ago Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning ... FHA lowers limits on loans Arizona Republic FHA Relaxes Program Rules for Homeowners Washington Post all 3 news articles

CMBS Market Begins to Show Fissures Wall Street Journal - 14 hours ago The rapid deterioration of these loans fed worries that the weakening economy and higher unemployment rate would drag down the $800 billion market for ... Big CMBS Loans Near Default; CMBX Soars, REITs Tank Seeking Alpha UPDATE 1-Big CMBS loans seen near default, index yields soar Reuters Commercial-Mortgage Bond Risk Rises After Loan Delinquencies Bloomberg Reuters - Wall Street Journal all 31 news articles

Loans to Detroit Salt Lake Tribune, United States - 8 hours ago The debate in Congress over a bailout of GM, Ford and Chrysler comes down to this: Should the taxpayers throw $25 billion in bridge loans to Detroit, ...

Boston Globe

Ailing automakers plead for $25b in loans Boston Globe, United States - Nov 18, 2008 The chief executives of Chrysler and Ford also pleaded for the loans, which would come on top of a $25 billion package approved in September to help the ... Auto Execs Reset Bailout Pitch; Republicans to Rewrite CAFE for Loans Ward's Auto (subscription) Republican Leader Presses Compromise as Auto Chiefs Renew Plea Bloomberg Big 3 automakers warn of crisis without bailout MarketWatch New York Times - MarketWatch all 1,669 news articles

Boston Globe

Housing agency loosens foreclosure aid rules Reuters - 15 hours ago The Hope for Homeowners program will now insure home loans that have had as little as 3.5 percent of their value erased by the original lender. ... HUD Said to Entice Banks to Enter Foreclosure Program (Update1) Bloomberg US broadens rules for mortgage-aid plan Philadelphia Inquirer Government To Let More Homeowners Swap For More Affordable Loans KWTX BusinessWeek - Seattle Post Intelligencer all 84 news articles

Sify

Loans to automakers make the only good deal for US Detroit Free Press, United States - 19 hours ago So consider this deal: For a loan of $25 billion, you could create an industry that would directly and indirectly create 13 million jobs, one out of every ... Big Three in need of loans Clarksville Leaf Chronicle Aid automakers with post-bankruptcy loans Concord Monitor Officials say without auto bailout loans, region will see a ... Oakland Press Denver Post - ZDNet all 872 news articles

Wachovia, Golden West Loans Probed by US Prosecutor (Update1) Bloomberg - 11 hours ago His office and SEC investigators in San Francisco are also scrutinizing whether the banks misled investors about the quality of Golden West's loans, ...

Pr. William Board Wants To Help Provide Loans Washington Post, United States - Nov 18, 2008 The Board of County Supervisors agreed in principle to make loans available to county employees, many of whom drive long distances to work because they ...