Before you sign up for a loan, you should ask yourself what you are hoping to get from it. There are tons of different types of loans in the world, and some of them might be more realistic for your budget, your long-term goals, and your instant needs.
Below we have a quick description to help you understand the difference between the 10 most common types of loans. Then you will be able to figure out which one makes the most sense to you.
Secured Loan vs. Unsecured Loan
All of the loans below will either be strictly secured or unsecured, or they will have the option for either. Because of this, it’s important to know what the two terms mean and which one is most helpful to you.
A secured loan is a loan that has a valuable item or multiple valuable items legally bound to it. This means that if you fail to pay your loan, the lender will be able to repossess this item as collateral. Because of this, secured loans tend to have cheaper interest rates.
Unsecured loans are harder to get and cost you more money on interest payments as the lender has taken a risk on you. This is because you have not bound an object to the agreement, thereby failing to pay will leave the lender out of pocket. To protect themselves, they will charge you more.
Ideally, secured loans are the better option because if you pay as per the agreement, your item will not be taken from you, and you will have a cheap loan. However, not everyone has an item worth the amount of their desired loan.
Mortgage loans are a prime example of secured loans. They are used to buying houses and other property. The house is often used as collateral if you fail to pay the mortgage. The house is worth the amount of the loan, which proves to the lender that you can pay back the money regardless of making the monthly payment.
Of course, you are still expected to pay, though, as otherwise the house will be taken from you.
This process allows regular people to buy houses that would typically take over 40 years to save up for.
Personal loans can be used for almost anything; weddings, vacations, medical payments, the list goes on. That being said, they tend to have a relatively short-term time. You are often expected to pay back a personal loan within 84 months.
Depending on your lender, this could be negotiated. For example, CreditNinja.com will personalize your loan’s term time to better suit your needs. As long as they can predict you can pay back the loan as per the new agreement, they won’t have a problem making something less generic.
These types of loans are designed for vehicles. They tend to last 3 to 7 years and allow the borrower to buy the car in installments instead of a one-off payment.
These loans are also often sold by car dealerships to help prospective buyers take home their cars. They sometimes get called “Buy Now Pay Later” loans.
It should be noted that these types of loans often cost double the amount of the original payment.
Home Equity Loans
Equity is when you own something that you could sell. Home equity means that you own some or all of your home. If you have paid off 50% of your home’s mortgage, then you own 50%.
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A home equity loan is basically a second mortgage. The idea is that you get a secured loan using the portion of your home which you own.
Legally you can borrow up to 85% of your home’s equity, and this is normally given to you in one lump sum. You either have to pay this back over a certain amount of time or when you pass away, that portion of your home then gets given to the lender. This is a popular option for elderly people.
Credit Building Loans
Credit Builders are short-term loans designed to help people who haven’t taken out any credit yet. Although people with bad credit can sometimes apply for these loans, the idea is to help those just starting out to gain a credit history before attempting to get a bigger loan, like a mortgage.
Debt Consolidation Loans
Consolidation loans are designed to help you streamline all of your debts and put them into one location. This will help you keep on track of your payments.
These types of loans are not always labeled as such. This is because the best consolidation loans are the ones with the lowest interest rates. The lowest interest rates are often only offered to new customers to entice them into the business. This means to get the best loan to consolidate your debts, you should be searching for a new lender every couple of years. This will allow you to put your debts into the best interest rate around, lowering the overall price.
Payday loans are loans designed to help you last until your next payday. You don’t need good credit to apply for them, which means they are the go-to option for people in challenging situations. For example, if you are near the end of your monthly pay packet and your car breaks down, a payday loan can be used to repair the vehicle, and you can repay the loan with your next check.
However, these loans are costly due to the fact that they don’t check your credit. If you can afford to avoid these loans, you should.
Pawn Shop Loans
Pawnshop loans are another expensive one. They work like a secured loan as you bring items like jewelry, games, or a TV into a pawn shop. The broker then values the item and lends you somewhere between 25% to 65% of the item’s value. You then receive a ticket and have to repay this debt within 30 days.
If you don’t pay within 30 days or if you lose your ticket, the broker can sell your item.
Think of it as a mixture between a payday loan and a mortgage.