Components of Loans

Early this month, we briefly mentioned loans, but what is a loan and what must a student look out for when considering one to pay for their higher education? To that I say, “Do not fear; we will show you the ins and outs of loans here!”

A loan is when a party borrows money from another with the agreement that the amount (plus a percentage) will be repaid to the lender. There are three basic components of loans: interest rate, term of the loan and security.

The interest rate is basically the extra amount the lender is charging the student to borrow their money. This is usually a percentage of the total amount loaned and can range greatly. The lower the interest rate, the better. It is very important that the student understands the exact amount of money that the interest is adding on to the loan, because it adds up quickly. There are two types of interest rates: fixed and variable. Fixed rates will not change throughout the life of the loan; on the other hand, variable rates will change depending on market conditions.

The term of a loan dictates the maximum amount of time the student has to pay the loan plus interest back in full. The term of a loan can be anywhere from 1 to 30 years. It is important to note that loans can be completely paid off before the term with no repercussions. The term of the loan will affect the student’s monthly payment, so it is something that will depend on the individual student.

Loan security is either secured or unsecured. A secured loan requires a collateral. This means that if the student does not pay the loan, the lender can keep that collateral. This guarantees that the lender will somehow get their money back. Contrarily, an unsecured loan requires no collateral so the lender cannot make their money back if the student does not pay back. However, unsecured loans usually have a higher interest rate because of the risk taken by the lender.

There is no universal correct way to decide on a loan. It depends solely on the individual student and their financial situation.

Look out for our next blog post to learn about the different types of student loans available.

Join us at World Future Forum for more research findings and best practices on student debt!