Types and suppliers of loans

If you've decided to borrow money, you have a choice of a number of different loans at a range of lending institutions. This chapter will describe some of the loans on offer and where you can obtain them.

Types of loans

The type of loan that you should apply for depends largely on your reason for borrowing. In general, lending institutions will charge more interest for smaller loans. Larger loans have a lower interest rate on the principal because they take longer to pay off and the lending institution will recoup more money in the long term.

Although less common, business loans for individuals often involve as much or more money than a housing loan. Capital is a general financial term for money used to set up a business. Borrowers take out a loan to start their business and aim to repay it through the profits from the business. If the business fails, the owner or owners are still required to repay the loan either by selling their assets, which could be physical property acquired by the business, such as furniture or computers, or intellectual property, such as a brand or design.

Personal loans are borrowing contracts for individual purposes, usually involving smaller amounts of money than housing or business loans. Lending institutions expect you to repay a personal loan at a faster rate than it takes to repay a housing or business loan and will therefore charge a higher rate of interest.

You may be asked to secure a loan by giving the lending party something as a guarantee that you will repay the amount. If you asked for a loan to buy a car, for example, the car may be used as security. If you defaulted on your repayments, the lending party could repossess and sell the car to recoup their money. If you took out a loan for another reason, such as a holiday, then the lending party may ask for something else as security or allow you to enter an unsecured loan contract.

An overdraft is a form of borrowing sanctioned by the lending institution, usually a bank, where the borrowing party withdraws more money, up to an agreed amount, than they actually have in their account. This form of borrowing attracts a high interest rate but is convenient for borrowers whose account balance often fluctuates between a negative and positive balance.

A credit card allows for small, regular loans with a lending institution on the premise that you pay back a minimum amount every cycle, a period determined by the issuer (usually a month). The lending party will set a credit limit, the maximum amount you can borrow at any one time, based on the amount they believe you can pay back during the cycle.

Loan suppliers

Loan providers range from banks and other financial institutions to retailers and private lenders. The lending party you approach may depend on the type of loan you seek, or it may come down to whether a certain supplier is more likely to approve your application. The type of lender you choose will also affect the terms of the loan, including the amount of interest charged.

Banks are the most popular type of lending institution, largely due to their stability and the variety of loans they offer. Because many people invest or keep their money in banks, banks can lend larger amounts to borrowers. Banks tend to offer loans at a lower interest rate, but they are also less likely to lend money to borrowing parties that they consider a risk, such as first-time borrowers.

Other financial institutions, such as building societies and credit unions, also have lending facilities.

A building society is a financial institution owned by its members, set up to lend money to borrowers for the purposes of purchasing property. The interest repaid by the borrowing party goes towards the interest received by the members, who have invested money in the society.

A credit union or co-operative lends in a similar manner to a building society, although credit union members usually belong to a specific organisation or group, such as a worker's union. Both generally charge a higher interest rate than banks and will lend money for purposes other than purchasing property.

Retail outlets often operate their own forms of credit to approved customers where the customer can pay for goods purchased with that retailer at a later date. Because the purchase amount represents less money than a housing loan, retailers will charge a higher interest rate on the principal. Some retailers also offer their own credit cards for purchases other than those at the retailer.

Credit card companies, with a source of money from a financial institution, are responsible for assessing borrowers and providing them with a credit card and a credit limit that will allow them to borrow money on a regular basis. While credit cards are easier to attain than other loans, the drawback is the higher interest rate charged.

You may also consider a loan from private lenders, such as a pawnbroker, or from people you know, such as friends and family. You would use this option for smaller amounts of money. Pawnbrokers are lenders who require a deposit, usually an item worth much more than the cash loan. They will keep the item and charge interest until you can repay the money. If you do not repay the loan by the agreed time, they are entitled to sell the item to recoup their money.

If you borrow money from friends or family, they may or may not charge you interest depending on the amount you borrow and the terms of the agreement, but without a contract, trust must exist between a borrower and lender in a personal relationship.