9 Types of Loans and When Each Makes Sense
- Understanding how your loan works before signing on the dotted line is important.
- Loans give you a lump sum of money upfront, which you’ll then repay over a set amount of time.
- There are nine main types of loans to familiarize yourself with — it’s also smart to become familiar with alternative financial solutions.
Loans give you a lump sum of money upfront, which you’ll then repay over a set amount of time. Different types of loans come with different terms of engagement. They also come with different levels of risk. All in all, there are nine types of loans that cover different life situations, from funding college to purchasing your first home.
How do loans work?
Before you browse the right loan type for you, it’s important to understand the basics of how loans work. Here are some common terms you’ll see in your loan paperwork:
- Secured loan: A secured loan is secured by collateral, such as a house or a vehicle. These loans tend to have lower interest rates.
- Unsecured loan: Unsecured loans are vetted more heavily through your financials and ability to repay rather than collateral. They tend to have higher interest rates.
- APR: There’s more to consider when taking out a loan than the interest rate. The annual percentage rate (APR) — which includes origination fees and other fees charged by your lender — is a more accurate measure of what it will cost you to repay your loan.
- Fixed rates: Fixed rates mean your interest rate or APR stays constant throughout the term of your loan.
- Variable rates: A variable rate loan may start with a lower interest rate, but this rate is subject to change and could go higher or lower depending on the larger financial landscape throughout the course of your loan.
What are the different types of loans?
There are many types of loans, but below are the most popular. Terms and requirements vary by loan type because each is designed for a specific purpose and may differ on key features.
| Loan type | Purpose | Typical loan term | Rate type | Eligibility focus | Collateral |
|---|---|---|---|---|---|
| Personal loan | Broad personal expenses (almost anything) | 12 to 84 months | Fixed | Credit, income and loan use | None (usually) |
| Debt consolidation loan | Combine multiple debts | 12 to 84 months | Fixed | Credit and income | None (usually) |
| Mortgage | To buy a home | Typically 10 to 30 years | Fixed or variable | Credit, income/assets and home value | Home |
| Home equity loan | Broad personal expenses (almost anything) | Five to 30 years | Fixed (loan) Variable, typically (line of credit) | Credit, income/assets and home equity | Home |
| Student loan | To pay for post-secondary education | 10 to 25 years (federal) Five to 20 years (private) | Fixed and set by government (federal) Fixed or variable and credit-based (private) | Program eligibility (federal) Credit, often with cosigner (private) | None |
| Auto loan | To finance a vehicle | 12 to 84 months | Fixed | Credit, income and car value | Car |
| Small business loan (SBA) | To fund business expenses | Varies by product | Varies by product | Business revenue, cash flow, time in business, credit | Business/personal assets, accounts receivable (when required) |
| Credit builder loan | To improve your credit score | 12 to 24 months | Fixed | Ability to provide collateral, debt-to-income ratio and/or banking habits | Savings/CD account or cash deposit |
| Payday loan | Bad credit emergencies (only after exhausting all options) | Two to four weeks | Fees that often equate to triple-digit APRs | Bank account and income | None |
Personal loan
A personal loan is a form of debt from a bank, credit union or online lender that’s disbursed in an upfront lump sum as cash. Typically, you’ll be charged a fixed APR, and you’ll repay the loan through predictable minimum monthly payments.
Personal loans are typically unsecured, meaning they’re not backed by collateral, though lenders may offer applicants with bad credit a secured loan.
Personal loans can generally be used for just about any purpose, and fast personal loans can give you funding within 24 hours. Here are some 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
A debt consolidation loan can help you to pay off current debts by combining them into a single loan, which can potentially save you money on interest and make monthly payments easier to track. Typically, these loans are unsecured.
A debt consolidation loan may not be best for borrowers with bad credit, as the interest rates offered may not make consolidating worthwhile. To evaluate whether this type of loan 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, as it allows you to purchase a home and build equity. Most mortgage loans have terms of 10, 15, 20 or 30 years, though longer or shorter terms are sometimes available.
Mortgages are secured loans — if you’re unable to repay your mortgage, you could lose your home in the process. They can come with fixed or variable interest rates.
There are many types of mortgage loans. The best one for you will depend on your personal situation:
- Conventional: Traditional loans that come to mind when most people think of mortgages. Conventional mortgages are fixed-rate, require good credit and private mortgage insurance, unless you can afford a down payment of 20% or more.
- FHA: These loans make homeownership a reality for some borrowers with limited savings or lower credit scores, but mortgage insurance is mandatory.
- VA: Veteran and active duty service members can secure these loans and pay no down payment or mortgage insurance, though your credit score plays a role in loan approval.
- ARM: Adjustable-rate mortgages (ARMs) have variable rates and are usually best for people who think they can pay off the loan or move within the first five to 10 years. That’s because the rate will vary after a set period, usually five or 10 years.
Home equity loan
A home equity loan, sometimes referred to as a “second mortgage,” allows borrowers to take advantage of the equity they’ve accumulated since buying their home.
Borrowing limits are typically capped at an 85% loan-to-value ratio (LTV) of your home’s value, though the specific amount will depend on how much equity you’ve built up and the lender.
Like a mortgage, home equity loans are secured by your home, so you need to keep current with payments. Home equity loan requirements may include a low debt-to-income ratio, a good credit score and at least 15% equity in your home.
Student loan
Student loans are a financing option for people who plan to pursue a post-secondary education. This type of debt can be split into two groups: private and federal student loans.
Federal student loans don’t have credit requirements, but you will be required to maintain good grades at an eligible college or university. Federal student loans have advantageous repayment programs, some of which are based on your income, while some loan balances are eligible for debt forgiveness after a period of consistent payments. Interest rates are fixed.
Private student loans are based on credit requirements, which means you may require a cosigner. These loans are typically unsecured, with payments due monthly and can come with fixed or variable rates. You won’t be eligible for the same advantageous repayment and forgiveness plans as federal student loan borrowers.
Auto loan
Auto loans allow you to purchase a new or used vehicle, which can mean anything from a truck to an RV.
Car loans typically come with fixed rates, with repayment terms that usually range from 36 to 84 months. Most auto loans are secured by the vehicle you’re purchasing as collateral, though some lenders offer unsecured car loans but you’ll need good to excellent credit to qualify.
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 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 offer SBA loans, which are backed by the Small Business Administration (SBA) and are often easier to qualify for, though the application process can be lengthy. SBA loans can be as large as $5.5 million.
Business loans sometimes require collateral, but that isn’t the only factor lenders take into account. As you navigate how to get a business loan, creditors will also consider your credit score, the age of your company and annual revenue.
Credit builder loan
Credit builder loans are 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, you’ll get access to the money at the end. After you’ve fully made payments with interest, the lender releases the loan funds to you. This allows you to log positive line items on your credit report without as much risk to the lender.
Building credit from scratch can take time, but the promise of receiving your loan funds may serve as a good motivator for some borrowers.
Credit builder loans aren’t very common, though you may have more luck finding one at a small financial institution, like a credit union.
Payday loan
Though the amount borrowed is typically $500 or less, payday loans are considered predatory due to high associated fees. These fees can equate to an APR of up to 400%. With an APR that high, you’d pay more than $75 to borrow $500 for two weeks.
With sky-high APR and 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 out 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, consider applying for a payday alternative loan at a credit union or applying for a loan with a cosigner.
Ask LendingTree: What’s the best type of loan for someone with bad credit?
If you have bad credit, consider joint or secured loans to keep your loan as affordable as possible. Since having a co-borrower or collateral decreases a lender’s risk, they’ll be more likely to offer you better rates.
You should still be realistic about what you’ll spend — you’ll likely see rates on the high end of your lender’s APR range — but whenever possible, avoid loans with an APR above 36%. High rates mean expensive payments, making it much harder to get out of debt.
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