You can use a loan to finance several life goals that you otherwise could not afford such as buying a new home or going to college. There are several types of loans and some are designed to serve specific purposes.
This is why you need to know the different types of loan options before you borrow any money so that you can figure out the one that suits your needs best. Before we discuss several loan types available for borrowers, let’s look at some loan terms that you need to be familiar with.
Loan Terms to Be Familiar With
- Secured Loans: For these to be approved, the borrower needs to use an asset they own as collateral. If they fail to pay back the credit, the lender has the right to take possession of the asset.
- Unsecured Loans: This is the opposite of secured loans. Here, no collateral is required. However, their interest rates are higher than their counterpart because of the risks involved for lenders. You can read this post to learn more about the difference between secured and unsecured loans.
- Installment or Term Loans: These are paid back over an agreed period via fixed payments.
- Fixed-Rate: When a loan is on a fixed interest rate, the interest rate typically won’t change, unless on very rare occasions. On such rare occasions, the lender has to send the borrower an increase notice before the change is implemented.
- Variable Rate: Unlike fixed-rate, the interest rate on a loan with a variable rate can change any time the prime rate changes.
- Revolving Credit: Here, you have a preset credit limit. When your billing cycle ends, you can choose to fully pay your balance. Or you can make the minimum payment and then revolve (carryover) the remaining balance forward to the following month.
Common Loan Types
1. Mortgage
A mortgage is used to finance a home purchase. The house bought will be used as collateral. If you miss payments, the lender can take possession of the property and then sell it off to get their money back.
The term of the mortgage can be over ten, fifteen, twenty, and even thirty years. There are several types of mortgages. Anybody with good credit can qualify for conventional mortgages but these aren’t backed up by any government agency. To be qualified for mortgages backed up by a government agency, you’d have to fall under a certain category.
The interest rates may either be fixed or adjustable based on the terms of the mortgage.
2. Personal Loans
Some loans are made for specific purposes like buying a house or car. However, when you get a personal loan, you can use the cash borrowed to do anything you like. For instance, some persons take personal loans to settle emergency expenses or finance their home renovation projects or even their weddings.
This type of lån is usually unsecured, so you won’t need to provide any collateral to get it. The interest rate may either be variable or fixed and the term could be for some months or even years.
3. Car Loans
These are used to finance a car purchase and just like with mortgages, the car being bought is the loan collateral. If you default payment, the lender can repossess the vehicle.
The terms of this kind of credit range from thirty-six to seventy-two months. However, with the increase in vehicle prices, the terms on car loans are becoming longer.
4. Home Equity/ Home Equity Line of Credit
With this type of lån, the borrower can take out a part of their home’s equity as a loan and then use the money borrowed for anything they want. These are term loans, meaning that a big sum of money is given to the borrower and they have to pay back the money in monthly payments over a period (often between five to thirty years).
Home equity line of credit (HELOC) is typically revolving credit. This means money can be taken out of the credit during “draw periods”. Then, the borrower has until the end of their draw period to pay back just the borrowed money interest. After which, they are given twenty years to repay the whole money borrowed.
HELOCs usually have variable rates while home equity has fixed rates.
5. Student Loans
These are used to finance both graduate and college schooling. You can get these from either a private lender or the federal government. Most people often prefer getting this loan from the government. This is because the government offers forgiveness, forbearance, deferment, and repayment options based on income.
The U.S Department of Education funds these credits and they are given all through the period in school. Credit checks aren’t required and the loan terms like fees, interest rates, and repayment periods are usually similar for everyone.
On the flip side, private lenders often require credit checks and terms including fees and rates vary from one lender to the other. They also lack some benefits which are offered by the federal government including repayment options that are income-based and forgiveness.
6. Payday Loans
Payday loans aren’t the most favorable type of lån because of how high their interest rates are. Sometimes, these fees can be so high that they become equivalent to a 400% APR. A payday loan is relatively easy to get; however, they have to be paid back once your next paycheck comes in.
But paying back fully isn’t so easy because of the high fees attached to it. So, most times, borrowers have to keep renewing the loan and this often leads to new charges. Not before long, the borrower may find themselves in a vicious debt cycle.
But some people still go-ahead to get them because of how poor their credit is. Instead of falling into this pitfall, we recommend that you build your credit score. Visit https://www.experian.com/ to learn how to do this. When your score is higher, you can get approved for other options that aren’t so expensive like credit cards and personal loans.
Conclusion
There are several types of lån for people to pick from to serve their specific needs at that point. For instance, a mortgage is used to finance the purchase of a new home. Likewise, a car loan is used to buy a car. Knowing all the various types of loans available to you can help you select one that suits your present needs.
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