A Beginner’s Guide to the Different Types of Loans

November 7, 2022

The average personal loan balance is $9,896. There’s been an increase in borrowing between 2021 and 2022.

With inflation, skyrocketing housing costs, and just about everything from gas to groceries getting more expensive, it’s harder to make ends meet than two or three years ago.

What happens if an emergency comes up? Your car can break down or you could have a drop in income.

You can get a personal loan to cover those expenses or you can use it to consolidate credit card debt.

It’s important to know the types of loans available, no matter what your reason for getting a loan. That prevents you from making a bad financial decision that hurts you more than helps you.

There’s no need to worry because we’ve got your back. Keep reading to learn about your loan options when shopping for personal loans.

Loan Subsets

There are a lot of terms to learn when you’re getting a personal loan. The first thing to know about the different types of loans is that they can fall into different subsets.

The most common subset describes the interest rate on a loan. You’ll find fixed-rate or variable-rate loans.

A fixed-rate loan means that the loan doesn’t change during the life of the loan. A variable-rate loan is a type of loan that gets adjusted on a regular basis to reflect the current interest rate.

In 2022, the Federal Reserve increased interest rates several times to slow down inflation. If you have a variable-rate loan, you’ll see your monthly payments go up.

Another subset tells you about the guarantee of a loan. Lenders want to make sure that the loan gets paid back, so they’ll ask for something to guarantee the security of the loan.

This is the difference between a secured and unsecured loan. A secured loan gets guaranteed by property or an asset. An unsecured loan doesn’t have such a guarantee.

Secured loans have lower interest rates than unsecured loans.

The final subset refers to the length of the loan. A loan can be a short-term loan, which gets paid back within a year.

At the other end of the spectrum is a long-term loan. It can get paid back between 1-30 years. A personal loan usually gets paid back within 3-5 years, while a mortgage gets paid back between 15-30 years.

Most Common Types of Loans

What are the most common types of loans?

Let’s start with a mortgage. It’s unlikely that you have several hundred thousand dollars around to buy a house, so you’ll have to get a home loan to finance the deal.

A mortgage is the most common type of secured loan. It’s secured by the property, so if you don’t pay the loan back, the bank take your home.

A mortgage can be a fixed-rate or variable-rate loan. When interest rates were near zero, people tried to take advantage of the rate and buy a new home.

That’s one of the reasons why the housing market was red hot for so long, even during the worst of the pandemic.

Now that interest rates are up, it makes sense to get a variable-rate loan once the Federal Reserve is done hiking interest rates.

You’ll get a mortgage with a higher interest rate, but once rates drop again, you’ll have that reflected in your payments.

Business Loans

Business loans are loans that have a specific business purpose. These loans usually get used to purchasing equipment or fund projects.

Business loans are usually secured if they’re used to purchase equipment. A construction company uses a loan to buy machinery.

The equipment secures the loan, so if the company goes under, the bank takes the equipment.

Personal Loans

Personal loans have been a popular form of consumer debt over the last 5-7 years. That’s because they’re easier to get than other types of loans. They give you more financial flexibility, too.

Personal loans are usually unsecured loans. They have better interest rates than credit cards and get used to consolidate credit card debt.

There are short-term personal loans, which you can use to fund a brief gap in cash. They’re also long-term loans that get paid back in a few years.

There are plenty of loan options, thanks to online lenders like loanz.com, Lending Tree, and SoFi. Most lenders will approve your loan in a few minutes.

Revolving Line of Credit

A revolving line of credit is a loan, but it works a bit differently because you don’t get a lump sum of money and pay it back in monthly installment payments.

It actually works more like a credit card than a standard loan.

A revolving line of credit score gives you access to funds. If you take out money from the line of credit, you should pay it back as soon as possible.

A line of credit usually carries higher interest rates than a personal loan.

Home Equity Loan

Do you own a home? Have you been paying off your mortgage for several years?

You have equity in the home. You can take that equity and use it to get another loan. This is common for people who want to remodel or renovate their homes.

You can also use a home equity loan to consolidate debt and pay a lower interest rate.

Also, Read: How Auto Loans Work?