What is a Consumer Loan?
A consumer loan is a loan given to consumers to finance specific types of expenditures. In other words, a consumer loan is any type of loan made to a consumer by a creditor. The loan can be secured (backed by the assets of the borrower) or unsecured (not backed by the assets of the borrower).
Types of Consumer Loans
- Mortgages: Used by consumers to finance the purchase of a house
- Credit cards: Used by consumers to finance everyday purchases
- Auto loans: Used by consumers to finance the purchase of a vehicle
- Student loans: Used by consumers to finance education
- Personal loans: Used by consumers for personal purposes
For qualified borrowers, consumer loans serve a multitude of purposes and are essential in helping them finance their life.
Secured vs. Unsecured Consumer Loans
Secured consumer loans are loans that are backed by collateral (assets that are used to cover the loan in the event that the borrower defaults). Secured loans generally grant the borrower greater amounts of financing, a longer repayment period, and a lower charged interest rate. As the loan is backed by assets, the risk faced by the lender is reduced. For example, in the event that the borrower defaults, the lender would be able to take possession of collateralized assets and liquidate them to repay the outstanding amount.
Unsecured consumer loans are loans that are not backed by collateral. Unsecured loans generally grant the borrower a limited amount of financing, a shorter repayment period, and a higher charged interest rate. As the loan is not backed by assets, the lender faces increased risk. For example, in the case of borrower default, the lender may not be able to recover the outstanding loan amount.
Categories of Loans
1. Open-end loan
An open-end consumer loan, also known as revolving credit, is a loan in that the borrower can use for any type of purchases but must pay back a minimum amount of the loan, plus interest, before a specified date. Open-end loans are generally unsecured. If a consumer is unable to pay off the loan in full before the specified date, interest is charged.
A credit card is an example of an open-end consumer loan. The consumer is able to make purchases on a credit card but must pay the outstanding amount when it becomes due. If the consumer fails to settle the outstanding amount on the credit card, he/she would be charged interest until the amount is paid off.
2. Closed-end loan
A closed-end consumer loan, also known as installment credit, is used to finance specific purchases. In closed-end loans, the consumer makes equal monthly payments over a period of time. Such loans are generally secured. If a consumer is unable to pay the installment amounts, the lender can seize the assets that were used as collateral.
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