9 Types of Loans and When to Use Them
Different types of loans can provide access to assets, career growth and other opportunities. All in all, there are nine types of loans you should know, and they cover different types of good and bad debt. Whether you’re looking for funds to attend college or buy your first home, here’s what you need to know about each kind of loan.
What are the different types of loans?
Though there are many types of loans, these are the kinds you’ll most likely see. Features of each loan type — like loan length and interest rates — can vary. The numbers in the table below are typical.
| Loan type | Purpose | Loan length | Interest rates | Credit check | Collateral required |
|---|---|---|---|---|---|
| Personal loan | A wide range of personal expenses, from home improvement to vacations | 12 to 84 months | Up to 36% annual percentage rate (APR) | Yes | Sometimes |
| Debt consolidation loan | Combining debts from various sources into one loan | 12 to 84 months | Up to 36% APR | Yes | No |
| Mortgage | To purchase a home | Typically 10 to 30 years | Averaging 7.90% for 30-year fixed mortgages | Yes | Yes |
| Home equity loan | A wide range of purposes including home improvement projects and medical bills | Five to 30 years | Starting at 7.99% APR | Yes | Yes |
| Student loan | To pay for a post-secondary education | 10 years (federal); five to 15 years (private) | Starting at 4.24% APR | Yes | No |
| Auto loan | To finance a vehicle | 12 to 84 months | Starting at 4.50% APR | Yes | Yes |
| Small business loan | To fund your business expenses | Up to 300 months | Starting at 3% APR | Yes | Yes |
| Credit builder loan | To improve your credit score if you have no or low credit | 24 months | Starting about 5% APR | Sometimes | Yes |
| Payday loan | Can be used for small purchases | Two to four weeks | Up to 400% APR | No | No |
Personal loan
Personal loans are a form of debt from a bank, credit union or online lender that come in one-time fixed lump sums. They come with fixed annual percentage rates (APRs) and fixed minimum monthly payments.
Some lenders charge additional fees for personal loans. One example is an origination fee, a one-time administrative fee you pay when you open your loan.
Since personal loans are typically unsecured loans, you won’t need collateral to apply for one. Instead, you need a good credit score and a consistent and solid credit history. However, some lenders offer secured loans if you have bad credit or want to qualify for lower rates.
Personal loans can generally be used for just about any purpose, and fast personal loans can give you funding within 24 hours. Here are a few of the common reasons to get a personal loan:
- Refinancing or paying off credit card debt
- Home improvement projects
- Medical bills
- Traveling
- Wedding/honeymoon costs
- Emergency expenses
Debt consolidation loan
You can use a debt consolidation loan to pay off any current loans by combining your various debt into a single loan. This may be advantageous to some borrowers: It could save you money on interest, make your monthly payments easier to track and help you pay off debt faster.
Since debt consolidation loans are a type of personal loan, they are generally unsecured and come with fixed interest rates. However, there are debt consolidation pros and cons to consider.
A debt consolidation loan may not be best for those with bad credit, as it may not be worth it if you can’t obtain a lower APR. To find out if this type of credit is a good fit for you, calculate your potential savings using a debt consolidation calculator.
Mortgage
A mortgage loan is likely the largest amount of money you’ll borrow in your lifetime and allows you to purchase a home and build equity. There are many types of mortgage loans — conventional, FHA and VA, to name a few — all of which depend on factors like your background and income.
Most mortgages loans are 10, 15, 20 or 30 years long, though you may also find longer or shorter terms. They can come with fixed or variable interest rates. Mortgages are also secured loans, meaning the home you purchase will serve as collateral while you repay it. Thus, if you’re unable to repay your mortgage, you could lose your home in the process.
Home equity loan
A home equity loan, sometimes referred to as a “second mortgage,” allows borrowers to take advantage of the equity they’ve built into their home since buying it. You can typically borrow a loan-to-value ratio (LTV) of up to 85%, though this may vary by lender. This means you can take out up to 85% of your home’s value.
Like a mortgage, home equity loans are secured by your home, so you’ll want to keep up with payments. Home equity loan requirements may include a low debt-to-income ratio, a good credit score and at least 20% equity in your home.
Student loan
Student loans are a financing option for those who plan to pursue a post-secondary education. Since some young people who want to continue their education haven’t built up much credit, when you apply for a student loan, you may have to use a trusted loved one — like a parent — as a student loan cosigner.
These types of loans are typically unsecured and can cover expenses ranging from room and board, books and tuition. They can come with fixed or variable interest rates.
This type of debt can be split into two groups: private and federal student loans. As the names imply, the former are originated by private companies, while the latter is funded by the federal government.
Auto loan
Auto loans are a type of debt that allows you to purchase a new or used vehicle, which can mean anything from a truck to an RV. Generally, auto loans are secured by the vehicle you purchased. Car loans come with fixed rates with repayment terms that can range from 12 to 84 months.
While most auto loans are secured by the vehicle you’re purchasing as collateral, some lenders also offer unsecured car loans, though you’ll need good to excellent credit to access them. To see how much money you can afford to borrow, use an auto loan calculator to estimate your monthly payments.
Small business loan
Small business loans are a type of credit that allow entrepreneurs to access capital to expand their growing businesses. This can mean using loan funds for equipment, purchasing inventory or even covering payroll. Some lenders even offer SBA loans backed by the Small Business Administration (SBA); these can be as large as $5 million.
Business loans typically require collateral, but that isn’t the only factor lenders take into account. When you go through the process of how to get a business loan, creditors will also consider your business credit score, how long you’ve had your company, your cash flow, debt-to-equity ratio and working capital.
Credit builder loan
Credit builder loans are a type of loan specifically designed to help consumers with no or bad credit to prove to lenders that they can be trustworthy borrowers. These loans are typically small — ranging from $300 to $1,000 — and work a bit differently than traditional loans.
Instead of getting a lump sum of cash or an asset upfront, the loan amount is stored in a secured bank account that you can only access once you pay off the loan. In this way, your loan acts as collateral. Building credit from scratch can take time, but the promise of receiving your loan funds after it’s paid off may serve as a good motivator for some borrowers.
However, credit builder loans aren’t very common, though you may have more luck finding one at a small financial institute, like a credit union.
Payday loan
With amounts typically up to $500, payday loans are considered a predatory type of lending due their sky-high interest rates (as high as 400%). Combined with short repayment terms of just two to four weeks, payday loans can easily trap borrowers in a cycle of debt, as they may have to take more loans to pay off their original payday debt.
Payday loans typically don’t require credit checks, which may make them attractive to borrowers with bad credit. If you’re having trouble qualifying for a traditional loan, instead consider applying for a payday alternative loan at a credit union or applying for a loan with a cosigner.
What to consider with different types of loans
No matter what type of loan it is, taking on new debt can be overwhelming. There are many factors to consider before signing your name on that dotted line. Overlooking certain details can cost you more money in the long run.
- Credit scores: Before applying for any type of loan, it’s important to check your credit scores and reports first. Your credit scores — the most common of which are FICO Score and VantageScore — will set the tone for what lenders you may qualify with and what APRs you may receive.
- Loan purpose: If you choose to take out a loan that offers a flexible loan purpose, you’ll still need to disclose to your lender how you plan to use the funds as some lenders have limitations on how loans can be used. Loans with specific purposes, like mortgages and auto loans, may require that you present the asset you plan to purchase with the money.
- APRs: This is how much it will cost you to take out a loan, including interest rates and fees. A good credit score and a strong credit profile can help you access lower APRs which, in turn, allows you to spend less money on the loan.
- Repayment terms: How much time you have to repay your loan has an impact on what APRs you’re paying. Typically, the longer your loan term is, the higher your APRs may be but the lower your monthly payments are. On the flip side, short repayment terms often come with lower APRs but higher monthly payments. However, other factors such as your credit score will also affect your APR and monthly payments.
- Borrowing limits: How much you’re allowed to borrow will depend on factors like your income, how you plan to use the loan and your credit history. Keep in mind, if you have bad credit, you may have a hard time getting a large loan amount.
- Secured versus unsecured loans: This is an important distinction to keep in mind — it can impact your APR, as well as the outcome of defaulting on a loan. When considering secured versus unsecured loans, the former tend to have lower APRs because they’re less risky for lenders due to collateral. However, if you default on a secured personal loan, your lender can seize your collateral, which your lender can’t do with an unsecured personal loan.