Understanding Different Types of Loans

People take out personal loans easily but often they do not understand exactly the different types of loans being offered. Debbie Sharwood, the Communications Head of Wonga.com, South Africa, says: “Prior to taking out a loan, it is extremely important that the borrower researches the kind of loans on offer, as well as the companies offering them.”

Dangers of not understanding the various types of loans

“Should a consumer take out a loan that is not needed, or it is an inappropriate loan, he or she could ultimately pay higher interest rates than necessary. This could result in unnecessary debt and could even place assets in danger should the consumer default on the loan.”

Sharwood provided the following analysis of the different types of loans available in South Africa:

Secured loans

When there is an asset of considerable value underlying the loan, such as a house or a vehicle, then the loan associated with that asset is called a secured loan. The money can be used against the purchase of the asset or the asset is put up as security for the loan. Larger secured loan are often linked to the prime interest rate.

The asset underlying a secured loan is called collateral. Because the lender has some security for handing out money against the collateral, this kind of loan is considered to be relatively low-risk. As a result the interest rate on secured loans is inclined to be relatively low. Also the amount of money that can be borrowed in this way is higher. Repayments on secured loans are also typically spread over a longer period.

Should the borrower default on paying off a secured loan then the collateral could be lost. In other words, the lender could seize your house or your vehicle in lieu of payment. They will then sell the asset and reclaim their money. Should the asset sell for more than the outstanding amount, the lender is not obliged to hand over the profit to the borrower.

Unsecured or personal loans

Bankers call unsecured loans, or loans without an underlying asset as above, personal loans. Obviously these types of loans are higher risk loans from the lender’s perspective because, should the borrower default on the repayments the lender has no recourse and will probably lose financially speaking. Credit providers tend to lend smaller amounts of money on this basis and over a shorter period than secured loans.

Do not think that if you do not pay back a personal loan that you will not face consequences. The lender might be out of pocket but the borrower might face a court judgement forcing her to repay the amount. A garnishee order might result, where a monthly amount is claimed from the borrower’s salary each month until the payment has been made. It is also possible for a court effectively to convert a personal loan as a secured loan so it will still be possible for a borrower who defaults on a personal loan to lose his house or another asset. Be careful when taking out these types of loans.

Home loans or mortgages

Buying a home is an enormous purchase and few buyers can afford to pay cash for a house. Home loans (also known as mortgages or bonds) are secured loans specifically designed for purchasing a home.

A home loan is slightly different from a personal loan because the buyer usually will be obliged to pay a deposit (about 10 to 15 percent of the purchase price, although lenders might demand as much as 20 percent) and usually these loans are repaid over a longer period. By default mortgage loans are secured loans, with the home being the underlying asset. Basically you stand to lose your home to the lender if you default on repayments.

Credit cards

When your credit card application is accepted the credit card holder is given a set amount they are able to spend. A credit card is a type of a loan because the credit card holder is free to spend the credit available. The understanding is that if the amount is not paid back in a specified period then a high interest rate will start to accrue to the card.

Credit cards are incredibly useful types of loans. They can be used for travel bookings, online shopping and even larger purchases, such as for vacuum cleaners and fridges, without having to go through the hassle of taking out a personal loan or opening a store account. In addition, credit cards are a useful tool for those who are planning to buy a home or a car. Potential lenders make sure that the credit card holder has paid her installments on time.

Credit cards are a doubled edged sword, though. Banks have a vested interest in the credit card holder failing to make the monthly installments for a couple of month as it means they will earn lots of money in charges and interest.

Student loans

Getting a strong qualification is important in an ever-increasingly competitive job market. University and college degrees are expensive. It may be necessary for students to take out a student loan in order to complete their studies. A student loan can cover just tuition fees, or it can include related expenses like text books and accommodation. Repayment of a student loan starts once the student has graduated and completed his studies. Interest rates vary depending on the loan amount and repayment period. These types of loans are increasingly popular among SA students.

Bottom line on types of loans

Understand the types of loans you are taking out. This is not a game. Your financial well-being is at stake. If you are in doubt, speak to a financial expert who can advise you on various types of loans.

Next step: Complete and submit the form on this page to apply for a loan

All info was correct at time of publishing