Types of loans and leases

Why people usually take out loans

People need loans for a variety of reasons. We usually distinguish between loans for larger purchases (or, more precisely, investment) and loans for (immediate) consumption. For an explanation of types of indebtedness, go to Debt and overindebtedness.

Real estate loans and mortgages

People take out real estate loans, often also referred to as mortgages or mortgage loans, to buy land, a house or an apartment. As the loan amount is usually quite high, the lending bank demands collateral that covers this amount. In mortgage loans, the bank has a lien on the property entered into the land register (which means that the bank has a legal claim to the property). If the borrower is unable to repay the loan or is late with repayments, the lien allows the bank to sell or auction off the property to recover the outstanding loan amount.

Real estate and mortgage loans are usually loans with a term of 15 to 30 years. Since land, houses or apartments represent assets of lasting value, loans taken out to buy them are comparatively low cost. That said, real estate and mortgage loans come with additional costs – for entry into the land register, verifications and setting up a pledge agreement – which need to be taken into account. 

Moreover, there are a number of additional criteria defined by the Financial Market Authority (FMA) that apply to real estate loans to private individuals (as set out in the regulation for sustainable lending standards for residential real estate financing (KIM-V), which came into force in August 2022).

Lending standards for private real estate loans

Consumer loans

If you do not have the money to buy (durable) goods, you can take out a consumer loan (also referred to as personal loan) to finance a purchase. Typical purchases for which people take out consumer loans are electronic devices (like computers, games consoles), household appliances (like fridges, washing machines) or furniture, but also holidays.

Consumer loans are usually paid back in monthly installments comprising both interest and principal repayment. Banks may demand collateral like, for instance, a lien in your wages or salary, life insurance or residual debt insurance, or a third-party guarantee.

Consumer loans allow people to frontload consumption, that is, they can buy something now and pay later. They are a quick and easy financing option. Online consumer loans are becoming increasingly popular, making it possible to receive money with just a few mouse clicks. However, it is important to know that these simple financing methods come with risks and costs that should be taken into account. Here are the main reasons why it is often not advisable to take out a loan for consumption:

1. The term of the loan is usually longer than the duration of use of the product or service you buy. You still have to pay back your loan when the vacation is over or the device you bought is broken. You have to cut down on spending for a longer period of time.
2. Borrowers may also take out several consumer loans and, over time, they may lose track of their debts and become unable to pay the installments on time or at all. Late payments usually cause very high additional costs (for example default interest and reminder fees).
3. Borrowers default more often on consumer loans than on other loans (e.g. mortgage loans). Banks factor in this default risk by demanding higher interest, which is why consumer loans are generally more expensive than other loans. 

Example: Costs of consumer loans

Consumer loans come in different forms so that sometimes people might not even be aware that they have actually taken out a loan. This may be the case when they buy something in installments, overdraw their bank account or pay for something by credit card.

Overdrafts

When you withdraw more money from your bank account than you actually have in your account, you are using an overdraft. This means that you borrow money from your bank. If the bank accepts this without having previously agreed an overdraft limit with you, this is called an unarranged overdraft. If you agree with your bank on the terms of an overdraft, including a limit, this is called an arranged overdraft.

Overdrafts are an expensive form of credit because the interest charged is usually very high. It is therefore advisable to use overdrafts only if absolutely necessary and only for a short period of time.

Installment purchases

Payment offers like “buy now, pay later" or "0% financing” often tempt people to make installment purchases so that they can buy and use goods immediately and pay later in several smaller amounts (installments). Payment in installments is nothing else but a loan with – usually – high interest and other costs. The creditor is required by law to disclose the effective interest rate that represents the total cost of the arrangement. Consumers should therefore compare offers on the basis of the effective interest rate.

The creditor is not necessarily the selling retailer; often, retailers cooperate with credit institutions that process such installment purchases. The selling retailer owns the good until the last installment has been paid. If the buyer is late with their installments or fails to pay, they may be charged default interest (5% maximum), which adds to the high costs of this type of loan. Finally, in this case, the selling retailer usually has the right to demand the immediate payment of all outstanding installments.

Credit cards

Credit cards are mostly used for cashless payments in many stores all over the world and online. The buyer’s account is not immediately debited with the amount due but – in most cases – only at the end of the month. This means that for the time between the purchase and the deduction of the amount due from the buyer’s account, the buyer owes money to the credit card issuer. If you pay your credit card bills on time, you will normally not be charged interest.

Foreign currency loans

A foreign currency loan is a loan denominated in a currency other than the national currency. In Austria, up until 2008, many borrowers took advantage of lower interest rates in Swiss francs, Japanese yen or US dollars and took out loans in these currencies instead of euro.

However, this type of loan is a speculative transaction that involves substantial risk and dangers:

These substantial risks are the reason why in Austria, banks are generally no longer allowed to make foreign currency loans to private individuals.

Leases

A lease can be an alternative to a loan. This arrangement allows you (as the lessee) to use an item (e.g. a car or a building) owned by someone else (the lessor) for a defined period of time. In return, the lessee pays a – usually monthly – fee (lease payment) until the end of the lease period. Car leasing is among the most widespread types of leases.

In contrast to purchasing with the help of loan financing, the ownership of the leased item remains with the lessor, who often demands advance payments. Some lease contracts, especially car lease contracts, contain an agreement concerning the residual value of the leased item. It specifies the minimum value that the leased item should have at the end of the lease term. If the value of the leased item is lower than the residual value, the lessee is obliged to pay the difference upon return of the item.  

The specific design and content of lease contracts may vary considerably. Often it is agreed that the lessee may buy the leased item after the end of the lease term or that the lessor may demand that the lessee buys the leased item (right to tender). Lease contracts usually also specify which party is responsible for the repair and maintenance of the leased item.