Types of Loans and Consolidation Strategy

Borrowing money from a bank or financial institution is generally referred to as a loan. It has two main parts, the principal or the amount you borrowed and the interest, which is what you pay the bank for lending you funds.

Loan types may be based on interest rates and collateral.

Fixed rate: This protects you against the risk of an interest rate increase by fixing it at a generally higher rate than a variable rate loan.

Variable rate: Because the interest on this loan fluctuates, your loan repayment can also change. In a declining interest rate market, with a variable rate, you can end up paying substantially reduced interest cost.

Secured: This type of debt is guaranteed by property you own such as a car or house, which guaranty is often referred to as collateral or security. Lenders prefer this type of loan because the collateral may be used to pay off the debt in case you default or are unable to settle your debt.

Unsecured: A credit card is an example of this type of loan in which the lender often charges higher interest. If you want to reduce your interest cost, financial experts recommend turning your credit card debt into a secured loan so that you can avail of the lower interest rate normally charged by banks for this type of loan.

Understanding the features and risks of each type of loan allows you to choose the best debt arrangement for your needs and implement the appropriate debt management strategy for it such as debt consolidation.

Debt consolidation: In this strategy, you bring together all your debts to form one large borrowing at a lower interest rate than your credit card’s.

Ideally, you pool together a bunch of unsecured debts such as credit cards and offer a security for the consolidated loan which collateral will serve to lower your interest rate without extending the payment period of your loans. When a debt is secured, the lender’s risk is reduced, allowing it to offer a lower interest rate.

Choosing your consolidator is important. If you are in danger of bankruptcy, a debt consolidator may buy your loans at a discount and pass off some of the savings to your total debt.

Many prefer this strategy because it can reduce your interest costs and in some cases even the total amount of your loan, making it easier for you to pay off the entire obligation. And dealing with one creditor may sometimes be easier than attending to as many creditors as there are debts.