Have you taken out a home or auto loan? Maybe a boat loan? Then you have taken out a closed-ended loan.
If you haven’t ever taken out a loan, or are simply trying to understand the difference between close-ended loans and other types out there, we can help you navigate this topic.
Closed-ended loans are loans where a fixed amount is borrowed and paid back over a specific period of time.
This article will break down what you need to know about close-ended loans and how they work.
What Are Closed-Ended Loans?
As we touched on above, closed-ended loans are very specific in how much you borrow, your payments, and how long you have to pay it back. When you receive this type of loan, the funds will be distributed in full up-front. You will then have a set amount of time to pay back the amount of the loan plus interest and any fees. Monthly payment amounts are set at the beginning of the loan.
With a close-ended loan, everything is set out ahead of time, so you know exactly what you will be paying for the length of the loan. These loan terms cannot be modified once you have agreed.
The loan amount is only distributed once, meaning if you pay it back, you cannot use that money again like you would with a credit card or line of credit.
Closed-ended loans are offered to borrowers through banks, credit unions, or other financial institutions.
Common types of close-ended loans include home, auto, boat, and student loans. You will likely take out some kind of close-ended loan at some point in your life.
Benefits And Drawbacks Of Closed-Ended Loans
Close-ended loans are useful if you are buying an expensive item like a home or car and need a large amount of money. There are definitely benefits to using this type of loan for purchases of this kind.
In order to be approved, you will need to disclose to the bank the reason for the loan. Until repayment is made in full, that financial institution is likely to retain some ownership rights over the property in case of default. Closed-ended loans are designed to be used for a specific purpose.
One of the best aspects of closed-ended loans is the upfront knowledge you have. When you are ready to sign the paperwork agreeing to the loan, you will know exactly how long you will be making payments and exactly how much the payments each month will be. Interest rates are fixed in place for the life of the loan.
Be sure to read the terms of your loan closely. One thing to watch for are penalties that could see you paying a fee for paying off your loan ahead of schedule. Penalties can also be incurred if you do not make payments on time, and if you were to default on the payments, the lender could repossess your property.
Comparing Closed-Ended Loans To Other Types Of Loans
If you are thinking of taking out some kind of close-ended loan, you might wonder if that is your only option. But what other types of loans are out there? Besides closed-ended loans, you will find open-ended loans available, and depending on the situation, that may be a better option.
Credit cards are probably the most popular kind of open-ended loans. The major difference between closed-ended and open-ended loans is the initial distribution of funds and the fact that the loan amount is revolving. This means that if you pay off all or a portion of the open-ended loan, you can take out that money and use it again and again as long as you keep making payments.
Unlike with close-ended loans, an open-ended loan has no restrictions on what you can do with the money you are borrowing. As long as you have a balance and make payments, you can use the money at your discretion.
Typically, you will take out a close-end loan when you need a higher loan amount for a pricier item. It is highly unlikely a regular person would have a credit card with a limit high enough to buy a house or a car.
Closed-ended loans will come into play when you are looking to purchase a home, a car, boat, or college tuition. Closed-ended loans have the added benefit of letting you know exactly what will be expected of you for the length of loan. You will know how much you need to pay each month and for how long, at a known interest rate.