What Are the Different Types of Loans Available?
What Are the Different Types of Loans Available?
When thinking about borrowing money, you need to carefully consider all options. Current rates, the amount you need to borrow, terms of repayment and your current obligations can all have a significant impact on your loan choice. You'll find that there are many loan options, too – each designed for a specific borrowing purpose.
A secured loan is usually needed when borrowing larger amounts to fund major purchases. This type of loan is contingent upon the borrower providing collateral or “security” to ensure repayment according to the agreed terms and conditions. For example, a popular secured loan is a home equity loan. To obtain a home equity loan, you must give the lender rights to your home as collateral; a mortgage is written against it. Likewise, with an auto loan, you are using the auto as the collateral for the loan.
Secured loans usually offer lower rates, higher borrowing limits and longer repayment terms than unsecured loans.
It’s important to remember that in the event a secured loan is not repaid and goes into default, the lender has direct recourse to the collateral and may be able to sell it to pay off all or part of the loan.
Examples of secured loans
- Home equity loan
- Home equity line of credit (HELOC)
- Auto loans (new and used)
- Boat loans
- Recreational vehicle loans
- Home improvement loans
With unsecured loans, the lender believes that you can repay the loan on the basis of your financial resources and creditworthiness. The lender does not take a lien on property or collateral, like a home or car, as security.
Unsecured loans are usually offered at higher rates than secured loans and have lower borrowing amounts.
Examples of unsecured loans
- Personal loan
- Personal line of credit
- Some home improvement loans
If you have a one-time borrowing need and prefer an uncomplicated borrowing option, an installment/term loan is probably your best bet. Once you receive the check for the loan amount, your borrowing is complete. You simply begin making your payments and continue until the balance is paid off. Your payment will remain the same throughout the term for easy budgeting.
Many borrowers prefer the simplicity of this arrangement. For a car, home improvements or a special event such as a wedding, an installment loan gets you the money you need and a payment schedule you can afford.
Lines of credit
A line of credit offers flexibility. It gives you the opportunity to borrow again and again without reapplying. Borrow as much or as little of your line of credit as you need, whenever you need it.
This flexibility means that the amount you owe can increase or decrease based on whether you've borrowed again or simply made your regular payments.
Let's say you're remodeling your kitchen and the job will take several months. A line of credit will let you pay the bills - wiring, appliances, wallpaper, cabinet installation - as they are due. Or perhaps you have a child in college and will be making tuition payments over a period of years. With a line of credit, all you need to do is write a check. You'll want to make sure that your credit limit is high enough to cover your projected needs. A line of credit is also valuable in the event of an unexpected expense such as car repairs or medical bills.
Consider your spending and credit habits before taking out a line of credit. If you have a history of fiscal responsibility and prudent borrowing, a line of credit gives you the freedom to manage your finances.
Review the following chart for an idea of whether a term loan or line of credit is best for you.
|Feature||Loan||Line of credit|
|Use in Emergency||No||Yes|
Fixed vs. variable loan rate
On a fixed rate loan, the interest rate remains the same throughout the term of the loan and the principal balance is steadily reduced as payments are made.
When a loan (including a variable rate line of credit and adjustable rate home equity loans) has a variable rate, the rate changes periodically to reflect market conditions. Variable rates are generally initially lower than those on fixed rate loans, but can change monthly. The rate on a variable loan can go up or down depending upon the index the loan rate is tied to. There is a built-in ceiling on how high a variable rate can rise so that it never exceeds a specific rate.
Loan rate vs. payment terms
A monthly loan payment reflects the interest and principal of the loan spread out over the loan term. When selecting a longer term loan, the monthly payment is reduced. However, more interest will be paid over the life of the loan.
Generally loans with shorter terms have lower interest rates, but they also have higher monthly payments because the loan is being paid back over a shorter period of time. A benefit of a shorter term is paying less interest over the life of the loan.
Which loan best matches your borrowing needs? At Dollar Bank, our loan experts are here to review all of the options with you and help select the loan that will work for you, now and in the future. Find a loan expert near you.
You can also try our loan calculators for assistance in estimating payments and more.
This article is for general information purposes only and is not intended to provide legal, tax, accounting or financial advice. Any reliance on the information herein is solely and exclusively at your own risk and you are urged to do your own independent research. To the extent information herein references an outside resource or Internet site, Dollar Bank is not responsible for information, products or services obtained from outside sources and Dollar Bank will not be liable for any damages that may result from your access to outside resources. As always, please consult your own counsel, accountant, or other advisor regarding your specific situation.
Posted: September 09, 2020