Different Loan Types Explained
There are many types of loans out there available for borrowers, so it can be difficult to keep them all in mind when searching for the perfect one. Here, we’ll provide you with an in-depth rundown of the most common loans available in order to help you make the best decision for your needs.
As the need for taking out financial help increases, so are different types of loans to satisfy this demand. We will here take a look at various loan categories to help you get not only a clearer picture but truly understand how they work.
How Do Loans Work?
If you’re new to this whole world of taking out a loan, you surely are wondering how they work. All types of loans essentially work the same, the borrower applies to receive the money from another party (lender) and agrees to use it for the purpose stated in this agreement. The borrower of course must be familiar with how the repayment works and the interest rate they will be paying. Different loans offer different terms and conditions as well as different pros and cons. Now let’s take a look at the types of loans available.
What Are the Most Common Loan Types?
Many variations have been created so the loans today can be used for many purposes. Here, we will cover some of the most common types of financial loans so you can choose the one that fits you best.
Personal Loans
There are many different types of personal loans available to borrowers. One of the most popular is an unsecured personal loan. This type of loan does not require any collateral, such as a home or car, to be put down in case you default on the loan. Lenders will use your credit score and credit history to determine how creditworthy you as a candidate are. Unsecured loans tend to have higher interest rates than secured loans because they’re seen as riskier investments for a lender.
In case you do have a certain asset and don’t mind putting it down as collateral, a secured loan could be a better option for you. Because there is something of yours a lender can repossess if you halt the loan, they will typically offer lower interest rates and better terms in general.
Personal loans are a great way to get money and use it for whatever purpose you want.
If you’re looking for a personal loan with more flexible repayment terms, you may want to consider a peer-to-peer loan. The good option may even be getting the money you need from a friend or a family member.
Personal loans usually have shorter terms of about 1 to 5 years, and the interest rates can be either fixed or variable.
Student Loans
These loans are, as the name suggests, intended for students who take them in order to pay for their education.
There are a few different types of student loans that you need to be aware of. The first type is the federal loan, which is backed by the government. These loans tend to have lower interest rates and more flexible repayment terms but can be harder to qualify for. The second type of loan is a private loan, which is not backed by the government. Private loans typically have higher interest rates and less flexible repayment terms. There are other variations to this, for example, you can even get co-signed student loans.
These loans typically have longer terms from about 10 to 20 years.
Auto Loans
Car loans are a type of loan borrowers take out to purchase a vehicle.
There are different loan options within this loan:
- Standard Auto Loan – The most common type of auto loan with a fixed interest rate. The term of the loan can vary depending on the lender but is typically around 36 months.
- Balloon Auto Loan – They have a lower interest rate than a standard auto loan. At the end of the term, there is a lump sum payment much larger than the previous monthly payments.
- Lease Buyout Loan – This is the loan intended for purchasing the car that you’re currently leasing. These loans typically have higher interest rates than standard auto loans, but the terms are shorter – usually around 12 to 24 months.
Payday Loans
Borrowers opt for these loans when they are in a tight financial spot and need cash right away. Payday loans are short-term loans that are typically due on your next payday. They offer just a small amount of money, typically less than $500, and are easy to qualify for.
People mostly use them to cover everyday expenses like bills, car repairs, groceries, or rent. They can and usually are issued on the same day. Nonetheless, they do come with high-interest rates and fees, so be sure you can afford to pay them back before taking one out.
Mortgage Loans
If you’re in the market for a new home, you’re probably researching different mortgage loans.
In common, they are a type of long-term financing, available for borrowers with good credit scores and offer good interest rates.
Let’s look at the different types of mortgage loans available:
- Fixed-rate loans. They have a fixed interest rate throughout the life of the loan. This means your monthly payments will stay the same, for the whole period of loan repayment. These loans are a good option if you plan on staying in your home for a long time and want predictable monthly payments.
- Adjustable-rate loans. These loans offer lower initial interest rates but they can change over time depending on the market conditions. They may be a good option if you don’t plan on staying in your home for a long time and are comfortable with some uncertainty in your monthly payments.
- Government-backed loans. These loans are backed by the federal government and typically have more favorable terms for homebuyers. This category includes VA loans, FHA loans, and USDA loans.
Debt Consolidation Loans
Debt consolidation loans are a great way to pay off multiple debts and improve your financial situation. There are many different types of debt consolidation loans available, so it’s important to choose the right one for your needs. In general, they consist of taking out one bigger loan to cover other loans you’ve collected in the past. This will simplify your monthly payments into just a single one and may possibly even lower it. Here, you can easily choose the repayment schedule that best fits your financial situation.
Debt consolidation works best for those who took a high-interest loan in the past or multiple of them as this can be a way for them to save quite a bit on interest fees.
Credit Builder Loans
If you’re looking for a way to improve your credit score or build some credit history if yours is limited, this is the right loan for you. You can usually only borrow between $300 to about $1,000. Making payments on time and in full will help you achieve a good score and make it easier for you to qualify for a loan you desire in the future.
Small Business Loans
There are many different types of small business loans available to business owners who are looking for a way to expand or finance their business venture.
One popular type of small business loan is the SBA Loan. The Small Business Administration is a government agency that provides financial assistance to small businesses. These loans are available through banks and other lenders, and they offer low-interest rates and long repayment terms.
Another popular type of small business loan is the line of credit. A line of credit is similar to a credit card, but it’s specifically for business expenses. Businesses can borrow up to a certain amount, and they only have to pay back what they’ve borrowed, plus interest.
Another alternative for small businesses is invoice financing. With this type of loan, businesses can use their outstanding invoices as collateral. This can be a great option for businesses that have slow-paying customers, as it allows them to get the cash they need right away.
These are just some of the available small business loans. Many more loans like these pop up every day as there is a higher than ever demand for them.
Home Equity Loans
A home equity loan is a second mortgage on your house. The loan is taken out based on the equity you have in your home. They can be used for a variety of purposes, including home improvements, debt consolidation, and investing.
There are two types of home equity loans: closed-end and open-end. Closed-end loans have a fixed interest rate and term, and you make fixed monthly payments. Open-end loans have a variable interest rate and no set repayment schedule. You can make payments as often as you want, but you must pay off the entire loan when you sell your home.
Home equity loans typically offer lower interest rates than other types, making them a good option for borrowers who need to consolidate debt or make major purchases. This is due to the fact that your home is the collateral here so if you default on a loan the lender can repossess it.
Title Loans
A title loan is a type of secured loan that offers quick cash. Here, the collateral is your car so be sure you can pay back the money you took out. Title loans are typically much shorter in duration than traditional loans and come with a bit higher interest rate. Still, they can be a good option for those who need money fast and don’t have the best credit.
In case you are considering this loan type, be sure to find a reputable lender and try to negotiate the terms so you get a better deal.
Final Thoughts
Now that we answered what the different kinds of loans are, you are probably wondering which one is the right fit for you? While we are not familiar with your personal situation and the needs you may have, we suggest you take this article for informational purposes to help you get educated on various loans offered by both traditional banks and many online lenders.
In case you need help in making a decision it would be a good option for you to find an experienced financial advisor to help you figure everything out.
