July 12, 2024
Kampala Daily
8 Different Types of Loans You Should Know

8 Different Types of Loans You Should Know

Loans can help you achieve major life goals you couldn’t otherwise afford, like attending college or buying a home. There are loans for all sorts of actions, and even ones you can use to pay off existing debt. Before borrowing any money, however, it’s important to know the type of loan that’s best suited for your needs. Here are the most common types of loans and their key features.

How Do Loans Work?

You can look at loan types by purpose or by how they function. Here are some basic loan terms borrowers should know. Unless otherwise noted, all are available from banks, credit unions and online lenders.

  • secured loan uses an asset you own as collateral; the lender can take the asset if you don’t repay the loan.
  • An unsecured loan requires no collateral. They usually have higher interest rates than secured loans because they are riskier for lenders.
  • An installment loan or term loan is repaid with fixed payments over a set period.
  • Revolving credit lets you borrow up to a predetermined credit limit. At the end of each billing cycle, you can either repay what you’ve borrowed in full or carry over (“revolve”) a balance to the next month, making only a minimum payment.
  • Fixed rate loans have an interest rate that doesn’t change during the loan term.
  • Variable rate loans’ interest rate may change with the prime rate (a baseline rate lenders use to set interest rates). If the prime rate climbs, your loan interest rate may climb as well.

Here are eight of the most common types of loans and their key features.

1. Personal Loans

While auto and mortgage loans are designed for a specific purpose, personal loans can generally be used for anything you choose. Some people use them for emergency expenses, weddings or home improvement projects, for example. Personal loans are usually unsecured, meaning they do not require collateral. They may have fixed or variable interest rates and repayment terms of a few months to several years.

2. Auto Loans

When you buy a vehicle, an auto loan lets you borrow the price of the car, minus any down payment. The vehicle serves as collateral and can be repossessed if the borrower stops making payments. Auto loan terms generally range from 36 months to 72 months, although longer loan terms are becoming more common as auto prices rise.

3. Student Loans

Student loans can help pay for college and graduate school. They are available from both the federal government and from private lenders. Federal student loans are more desirable because they offer deferment, forbearance, forgiveness and income-based repayment options. Funded by the U.S. Department of Education and offered as financial aid through schools, they typically don’t require a credit check. Loan terms, including fees, repayment periods and interest rates, are the same for every borrower with the same type of loan.

Read Also: Types of bank accounts

Student loans from private lenders, on the other hand, usually require a credit check, and each lender sets its own loan terms, interest rates and fees. Unlike federal student loans, these loans lack benefits such as loan forgiveness or income-based repayment plans.

4. Mortgage Loans

A mortgage loan covers the purchase price of a home minus any down payment. The property acts as collateral, which can be foreclosed by the lender if mortgage payments are missed. Mortgages are typically repaid over 10, 15, 20 or 30 years. Conventional mortgages are not insured by government agencies. Certain borrowers may qualify for mortgages backed by government agencies like the Federal Housing Administration (FHA) or Veterans Administration (VA). Mortgages may have fixed interest rates that stay the same through the life of the loan or adjustable rates that can be changed annually by the lender.

5. Home Equity Loans

A home equity loan or home equity line of credit (HELOC) lets you borrow up to a percentage of the equity in your home to use for any purpose. Home equity loans are installment loans: You receive a lump sum and pay it back over time (usually five to 30 years) in regular monthly installments. A HELOC is revolving credit. As with a credit card, you can draw from the credit line as needed during a “draw period” and pay only the interest on the amount borrowed until the draw period ends. Then, you usually have 20 years to pay off the loan. HELOCs generally have variable interest rates; home equity loans have fixed interest rates.

6. Credit-Builder Loans

A credit-builder loan is designed to help those with poor credit or no credit file improve their credit, and may not require a credit check. The lender puts the loan amount (generally $300 to $1,000) into a savings account. You then make fixed monthly payments over six to 24 months. When the loan is repaid, you get the money back (with interest, in some cases). Before you apply for a credit-builder loan, make sure the lender reports it to the major credit bureaus (Experian, TransUnion and Equifax) so on-time payments can improve your credit.

7. Debt Consolidation Loans

debt consolidation loan is a personal loan designed to pay off high-interest debt, such as credit cards. These loans can save you money if the interest rate is lower than that of your existing debt. Consolidating debt also simplifies repayment because it means paying just one lender instead of several. Paying off credit card debt with a loan can reduce your credit utilization ratio, improving your credit score. Debt consolidation loans can have fixed or variable interest rates and a range of repayment terms.

Read Also: Types of bank accounts

8. Payday Loans

One type of loan to avoid is the payday loan. These short-term loans typically charge fees equivalent to annual percentage rates (APRs) of 400% or more and must be repaid in full by your next payday. Available from online or brick-and-mortar payday lenders, these loans usually range in amount from $50 to $1,000 and don’t require a credit check. Although payday loans are easy to get, they’re often hard to repay on time, so borrowers renew them, leading to new charges and a vicious cycle of debt. Personal loans or credit cards are better options if you need money for an emergency.

What Type of Loan Has the Lowest Interest Rate?

Even among loans of the same type, loan interest rates can vary based on several factors, such as the lender issuing the loan, the creditworthiness of the borrower, the loan term and whether the loan is secured or unsecured. In general, though, shorter-term or unsecured loans have higher interest rates than longer-term or secured loans.

Your credit score and debt-to-income ratio can affect the interest rates you’re offered—getting low-interest rates usually requires good to excellent credit.

  • Mortgages usually have the lowest interest rates because they are secured and repaid over a long period. As of September 30, 2021, the average mortgage rate on a 30-year fixed-rate mortgage was 3.01%.
  • Interest rates for federal student loans first disbursed on or after July 1, 2021, and before July 1, 2022, range from 3.73% to 6.28%; private student loan interest rates range from 1.04% to 12.99%.
  • For a 48-month auto loan, the average interest rate was 5.28% as of May 2021.
  • The average APR on a two-year personal loan was 9.58% as of May 2021.

In comparison, the average credit card APR was 16.3% as of May 2021.

The Bottom Line

Whatever type of loan you seek, good credit can help improve your odds of getting approved for favorable interest rates. Before searching for loans, check your credit report and credit score to see where you stand. You can use Experian CreditMatch to get matched with loans based on your credit profile.

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