Loan Basics

Loan Basics

Are you ready to test your knowledge about loans and the lending process? This ten-question multiple-choice quiz will explore some fundamentals of loans, how they work, and the different types available. After completing all ten questions, click "Grade Me!" at the end of the quiz to see how you did.

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Interest rates are generally lower for secured loans versus unsecured loans. Why?
A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. It is this aspect of the loan, and not the borrower´s qualifications to repay the loan that will usually make interest rates lower for a secured loan versus an unsecured loan. Borrower qualifications, such as their income or FICO score may impact the interest rate as well, but that is generally true for both secured and unsecured loans.

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Which of the following is NOT a characteristic of an "amortized loan"?
Monthly payments for amortized loans are consistent throughout the loan term. With an amortized loan, the monthly payment is applied first toward reducing the interest balance, and any remaining sum towards the principal balance. As the loan is paid off, monthly interest charges lessen and a progressively larger portion of the payments goes toward principal reduction. Almost all amortized loans allow the borrower to pay off the loan by paying the outstanding loan balance plus currently accrued interest for the last month prior to repayment.

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When calculating the "Annual Percentage Rate" for a loan, the following items must be used in the calculation:
The "Annual Percentage Rate", or APR for a loan is the annual rate that is charged for borrowing, expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with obtaining the loan or incurred during the life of the loan.

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Which of the following statements is NOT TRUE regarding setting up a "bi-weekly" payment schedule:
When you make bi-weekly payments on a loan, you make a payment every other week, or 26 times per year. As a result of both making 26 payments per year, you will pay off more of the loan than if you made 12 monthly payments. You will also reduce the loan balance earlier each month than you would otherwise do with monthly payments and will accrue less interest each month. Both of these features will help you pay off the loan earlier than you would if you made 12 standard monthly payments. But you should check with your lender before starting a bi-weekly payment plan, because not every loan is eligible for such a repayment strategy.

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You will likely receive a better interest rate on a loan if you:
The interest rate you are offered on a loan is dependent on a lot of things, mostly revolving around lender risk. So, when you have been judged to be more credit-worthy (as seen through your FICO score), or put more of your ´skin in the game´ with a larger down payment, lenders will likely offer you a lower rate because you´re less of a credit risk. Likewise, shorter term loans often come with lower rates because lenders can more easily forecast the cost of credit over a shorter loan period than they can a long one.

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When a store offers 0% interest for 12 months on a credit purchase, generally speaking:
Always read the fine print. Most retail credit offers provide for 0 percent interest during the promotional repayment term. In most cases, the purchase will still accrue interest during that term at the store card´s standard rate, but if the balance is paid off during the promotional period, those interest charges are waived. If the balance is not paid off, you´ll have interest accrued from the date of purchase added to your outstanding balance. In some cases, retailers (or car dealers) will offer 0 percent financing throughout the loan term. You´ll typically need a strong FICO score to qualify for such offers, but if you do, you generally will not pay interest over the term of the loan and will only repay the principal. But keep in mind that when such an offer is made, the retailer or dealer is likely thinking they´re going to profit off of your relationship in other ways. So keep a sharp eye for price hikes or add-ons that may increase your overall cost of purchase.

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When you obtain a "line of credit" from a lender, you:
When you open a line of credit with a financial institution, the lender will establish a maximum loan balance that the borrower cannot exceed during the term the line of credit is open. Borrowers are typically free to borrow any amount up to the maximum during the loan term, pay down the balance and then borrow against it again until the line of credit expires and the full repayment period begins. During the initial term, borrowers are typically expected to repay a percentage of the outstanding balance, or at a minimum, any interest accrued during the month.

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A loan amortization schedule shows:
An amortization schedule shows a complete table of periodic loan payments, broken down by the amount of interest paid and the principal to be repaid each month from the first to last payment. For amortized loans, the payment is the same each month, but the amount going to interest and principal with each payment will change each payment period. Over time, the percentage of each payment going towards interest will decrease as the loan balance decreases. Since the loan payment remains the same, the remaining portion going to pay down the loan amount will increase.

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If you take out a consolidation loan, you will pay less over the repayment period if:
While paying a lower monthly payment on your consolidation loan may be beneficial from a cash flow perspective, it will likely result in you paying more over the repayment term if the repayment term is longer or the APR is higher than your prior loans. To make sure you will pay less over the repayment term, it is important to obtain a consolidation loan that offers a lower APR and where you can repay the consolidation loan over the same or shorter period than your prior loans.

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When buying a car and the dealer is offering 0% financing or Cash Back, you should:
It always pays to shop around. If you can apply the Cash Back to the down payment of your vehicle, you´ll lower the loan amount. If you can find a lender who offers a low enough interest rate on the reduced loan amount, you´ll often times pay less over the term of the loan by taking the Cash Back and going with a different lender. However, if the additional interest you´ll pay over the loan term with the alternative lender is greater than the Cash Back, you could be better off taking the 0 percent financing offered by the dealer.

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