Understanding the types of loans can seem overwhelming, but knowing the basics is a good start. Knowing your types of loans is essential whether you want to finance a major purchase, consolidate debt, or invest in your future. Let’s examine the different types of loans—from the main categories to the specifics and even the most pressing questions. 

What are the four types of loans? 

Let’s start by discussing the main categories that most types of loans fall into. Here are four common types of loans and what you need to know about each. 

Unsecured loans 

An unsecured loan is a loan that doesn’t require collateral. Put simply, all you need to do is repay it. When applying for funding with unsecured installment loans, you do not risk losing personal property.  

While many unsecured loan options are available, getting approval for one may be difficult if you have a poor credit history. For those who don’t already have excellent credit, the interest rate and the low loan offer amount may come as a surprise. Creditors use high rates to counteract the risk of lending money to those with poor credit. 

Secured loans 

Obtaining a secured loan involves pledging personal property as collateral. Specific types of loans may require particular assets like real estate or a vehicle (especially if you’re taking a loan to fund either of the two). If there isn’t any physical property to register as collateral, you can secure funding through: 

• Stocks 

• Cash (in a savings or certificate of deposit (CD) account) 

• Jewelry 

• Future paychecks 

• And more 

Using an asset as collateral allows borrowers to take out larger loans, benefit from reduced interest rates, and have longer repayment periods. Nevertheless, secured loans are risky, as defaulting on payments could result in losing the collateral. 

Fixed-rate loans 

A fixed interest rate remains constant during the entire repayment period. When borrowers opt for a fixed-rate loan, they make consistent monthly payments. Fixed-rate loans provide a reliable payment plan, which simplifies the budgeting process. 

Most loan choices come with fixed interest rates, allowing you to easily request loans with consistent monthly payments. This stability in payment amounts makes fixed-rate loans preferable for people seeking predictability in their financial management. 

Variable-rate loans 

As the name states, this kind of loan entails a rate that fluctuates every month. How? The principal balance and the current market interest rate determine the amount borrowers pay each month.  

Budgeting with a variable interest rate can be more challenging because the interest rates can vary between low and high. It can also be risky. Although getting a low monthly payment with variable rates is possible, you risk paying a high amount. This unpredictability makes it challenging to plan for long-term finances. 

Beyond the basics: more types of loans 

How many types of loans are there? While we have the main four categories above, here are the most common ones:

Personal loans 

Personal loans can be used for various purposes, including consolidating debt, paying medical bills, or funding large purchases. Generally, these loans do not require collateral and may come with fixed or variable interest rates. Typically, borrowers must have a good credit history to obtain favorable terms. 

Mortgages 

Mortgages are loans to purchase real estate secured by the property bought. To be more exact, if the loan is defaulted on, the creditor can foreclose on the home. This kind of loan comes with fixed or adjustable interest rates and can have terms from 15 to 30 years. 

Home equity loans 

Home equity loans let homeowners borrow money using the equity in their homes as collateral. These loans can be used for significant expenses like home renovations. Because they are secured by the house, they often have lower interest rates. Still, there is a risk of foreclosure if the borrower doesn’t make payments. 

Auto loans 

As noted in the secured loans section, auto loans finance the purchase of a vehicle. What makes them secured loans is that the vehicle is secured as collateral. These loans usually have fixed interest rates and terms ranging from three to seven years (with better rates available to those with stronger credit). 

Small business loans 

Small business loans fund entrepreneurs and business owners for various purposes, such as startup costs, expansion, or operational expenses. These loans can be secured or unsecured, often requiring a solid business plan and a good credit history. 

Student loans 

This type of loan is designed to help with higher education costs, such as tuition, books, and living costs. These loans can be federal or private, with federal loans providing more adaptable repayment choices and lower interest rates. 

Credit-builder loans 

Credit-builder loans are designed to help individuals build or improve their credit scores. The borrower makes payments into a savings account, which serves as collateral for the loan.  Once the borrower repays the loan, they gain access to the savings and benefit from an improved credit history. 

Choosing the right types of loans 

Loans come in different shapes and sizes and with so many options out there to choose from, choosing the right one can save you financial stress- or cause it!   

To help choose the right loan here are some key factors to consider:  

• Loan Purpose: Understand why you are taking a loan, is it for the purpose of buying a home? starting a business? consolidating debt? 

• Bank Interest Rates: Fixed rates offer stability, making it easier for you to plan your payments accordingly. 

• Repayment Terms: Short-term loans may have higher monthly payments but less interest overall, make sure to study what you think suits you best. 

• Credit Score: Your credit score impacts the loan terms you’re offered, so make sure your score is high so you can ensure good rates! If your score is low, here it how to increase your credit score.  

What if the loans turn into debt?  

When a type of loan turns into debt – you’re either stuck paying it off, facing the consequences of tying your belongings to a loan, or otherwise. This turn of events becomes a predicament, no matter your financial situation. If you’re facing debt from an unsecured loan, that’s where Clarity comes in. Reach out to help sweep away your debt without the burden of shouldering it alone.

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Disclaimer: The information provided here is for general informational purposes only and does not constitute legal, financial, or tax advice. Laws and regulations vary by state and individual circumstances, so always consult a qualified professional for personalized guidance.