8 Loan Types You Should Know
 |
| 8 Loan Types You Should Know |
Loans may help you attain big life objectives that you might otherwise be unable to afford, such as attending college or purchasing a house. There are loans for a variety of purposes, including repaying previous debt. However, before borrowing any money, you should determine which sort of loan is most suited to your circumstances. Here are the most popular loan types, along with their major characteristics.
How do loans work?
You may categorize loan types based on their purpose or function. Here are some fundamental loan terms that borrowers should understand: Unless otherwise specified, all are accessible via banks, credit unions, and internet lenders.
A secured loan uses an asset you own as collateral, and the lender may seize the item if you fail to repay it.
An unsecured loan does not need any collateral. They frequently have higher interest rates than secured loans because lenders consider them riskier.
An installment loan, often known as a term loan, is repayable in predetermined amounts over a specified period of time.
Revolving credit allows you to borrow up to a specified credit limit. At the conclusion of each billing cycle, you may either refund the whole amount borrowed or carry over ("revolve") a debt to the next month, paying just the minimum payment.
Fixed-rate loans have an interest rate that remains constant throughout the loan period.
The interest rate on variable-rate loans may fluctuate in tandem with the prime rate (a benchmark rate used by lenders to determine interest rates). If the prime rate rises, your loan interest rate may also increase.
Here are the eight most common loan types, along with their major characteristics.
1. Personal loans
While vehicle and mortgage loans are intended for certain purposes, personal loans may be used for anything you choose. For example, some people use them for unexpected bills, weddings, and home improvement projects. Personal loans are often unsecured, which means they don't need collateral. They may have fixed or variable interest rates, with payback lengths ranging from a few months to many years.
2. Automobile Loans
When you buy a car, an auto loan allows you to borrow the purchase price minus any down payment. The automobile acts as security and may be repossessed if the borrower fails to make payments. Auto loan lengths typically vary from 36 to 72 months, with longer loan periods becoming increasingly popular as vehicle costs climb.
3. Student Loans
Student loans might help you pay for college or graduate education. They are offered by both the federal government and commercial lenders. Federal student loans are preferred since they include deferral, forbearance, forgiveness, and income-based repayment choices. They are normally not subject to a credit check, funded by the United States Department of Education, and distributed as financial assistance via schools. Loan conditions, such as fees, payback durations, and interest rates, are consistent for all borrowers with the same sort of loan.
Student loans from private lenders, on the other hand, often need a credit check, and each lender determines its own loan conditions, interest rates, and fees. These loans do not provide debt forgiveness or income-based repayment options, unlike federal student loans.
4. Mortgage loans
A mortgage loan is for the purchase price of a property, less any down payment. If mortgage payments are not made on time, the lender may foreclose on the property as collateral. Mortgages are usually repaid over ten, fifteen, twenty, or thirty years. Government agencies do not cover conventional mortgages. Certain borrowers may be eligible for mortgages guaranteed by government entities such as the Federal Housing Administration (FHA) or the Veterans Administration (VA). Mortgages may have fixed interest rates that remain constant for the loan's duration or adjustable rates that the lender can vary on an annual basis.
5. Home equity loans
A home equity loan or line of credit (HELOC) allows you to borrow up to a percentage of your home's equity for any reason. Installment loans include those for home equity. You get a lump payment and repay it over time (typically five to thirty years) in regular monthly installments. A home equity line of credit (HELOC) is revolving credit. As with a credit card, you may draw from the credit line as required during a "draw period" and only pay interest on the borrowed amount until the draw period expires. Then, you typically have 20 years to repay the debt. HELOCs often have variable interest rates, while home equity loans have fixed rates.
6. Credit-Builder Loans
A credit-builder loan is intended to help people with bad credit or no credit rebuild their credit, and it may not require a credit check. The lender deposits the loan money (usually $300 to $1,000) in a savings account. You then set up monthly payments for six to twenty-four months. When the loan is returned, you get the money (with interest in certain situations). Before applying for a credit-builder loan, ensure that the lender reports it to the main credit bureaus (Experian, TransUnion, and Equifax), since on-time payments may help you enhance your credit.
7. Debt consolidation loans
A debt consolidation loan is a personal loan used to repay high-interest debts, such as credit cards. These loans might save you money if the interest rate is lower than your current debt. Consolidating debt also simplifies payments because you only have to pay one lender, rather than several. Paying off credit card debt with a loan might lower your credit usage ratio, which boosts your credit score. Debt consolidation loans might have fixed or variable interest rates and a variety of repayment options.
8. Pay-day loans
Payday loans are one sort of borrowing you should avoid. These short-term loans generally have costs comparable to annual percentage rates (APRs) of 400% or higher and must be returned in full by the next paycheck. These loans, which are available from both online and physical payday lenders, typically range from $50 to $1,000 and do not require a credit check. Although payday loans are simple to get, they are sometimes difficult to return on time, so borrowers renew them, resulting in more penalties and charges and a vicious cycle of debt. If you need money in an emergency, personal loans or credit cards are your best alternatives.
What kind of loan has the lowest interest rate?
Even among loans of the same type, interest rates may differ depending on a number of criteria, including the lender offering the loan, the borrower's creditworthiness, the loan period, and whether the loan is secured or unsecured. However, shorter-term or unsecured loans often have higher interest rates than longer-term or secured loans.
Your credit score and debt-to-income ratio might influence the interest rates you're given; low interest rates often demand strong to exceptional credit.
Mortgages often offer the lowest interest rates since they are secured and repaid over time. On September 30, 2021, the average mortgage rate for a 30-year fixed-rate mortgage was 3.01%.
Interest rates for federal student loans issued on or after July 1, 2021, but before July 1, 2022, vary from 3.73% to 6.28%, while private student loan interest rates range from 1.04% to 12.99%.
The average interest rate on a 48-month vehicle loan was 5.28% as of May 2021.
A two-year personal loan's average annual percentage rate was 9.58% in May 2021.
In contrast, the average credit card APR was 16.3% in May 2021.
The bottom line
Whatever form of loan you want, strong credit might increase your chances of being accepted for low interest rates. Before applying for a loan, check your credit report and score to determine where you stand. You may use Experian to find loans that fit your credit profile.
