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Curious Cat Investing Dictionary: Personal Loans
by John Hunter
Personal Loans are either secured of unsecured loans to an individual. Secured loans have some form of collateral such as a car, stocks (margin loan) or a house (home equity loan). Unsecured loans are usually involve less paperwork (which is often an attraction). The interest rate on unsecured loans is normally higher since the lender does not have collateral.
Credit cards are a form of unsecured personal loan. They normally are the worst way to borrow money (though for a very short term loan (say a month or 2) when you factor in the ease of use they can be the best option. The problem is many people treat their credit card as a normal source of loans. This is a bad personal finance strategy, in general. See our credit card tips page.
Personal loans often have "teaser" rates - interest rates that are low (and quoted in big bold colors) while the real rate is hidden in small type. Don't fall for the hype. The Annual Percentage Rate (APR) helps you look through the hype to the real cost, but is still not a perfect measure of the cost to the borrower.
- Annual Percentage Rate (APR) - the rate of interest factoring in fees. APR is an attempt to make differing loans more comparable by requiring a standard way to quote the cost to the consumer. APR is a useful measure but it still does not convey the entire picture in most instances.
- Debt consolidation loan - a loan to pay off several outstanding loans presumably at a lower rate. This can be a wise move but it also is historically one of the targets of "predatory lenders".
- mortgage loans
- Collateral - something of value that is offered to secure the loan. If the borrower fails to repay the loan the collateral can be sold by the lender to recoup the money they lent.
- "payday loans" - often extremely expense very short term loans to be paid back when the next paycheck is received (so also a low loan amount). Normally far too expensive and should be avoided. It is the expense that is normally associated with them that is the problem (there is noting innate to a very short term loan that is a problem). Check the APR and finance charges for any payday loan.
- "predatory loans" - loans made that are seen as unfair named partially due to the fact that these loans are often sold using high pressured sales pitches to people not even looking for loans. Naive borrowers are pressured into loans they don't understand with unreasonable fees, terms and interest rates. The elderly are also often the target of predatory lenders. These lenders are often then sued for fraud but not until great harm has been done to the victims.
- Line of credit - the promise to loan up to a certain amount of money. Often the interest rate will be an adjustable rate and will change as the market for interest rates change. A home equity line of credit using the value of the house as collateral for the credit. An advantage is you only have to pay interest on the money you actually borrow and you know up front how much you may borrow. A disadvantage for a home equity loan is your home is then risked if you cannot pay what you owe.
Related term: basis points