9 Types of Loans and When Each Makes Sense
Different types of loans can provide access to assets, career growth and other opportunities. All in all, there are nine types of loans you should know, and they cover different types of good and bad debt. Whether you’re looking for funds to attend college or buy your first home, here’s what you need to know about each kind of loan.
What are the different types of loans?
Though there are many types of loans, these are the ones you’re most likely to see. 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
Fixed rates don’t change. Variable rates can rise or fall, which may change your monthly payment.
| 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 a 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 your 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 come in one-time fixed lump sums. It comes with fixed annual percentage rates (APRs) and fixed minimum monthly payments.
Some lenders charge additional fees for personal loans. One example is an origination fee, a one-time administrative fee you pay when you open your loan. Origination fees aren’t usually out of pocket. Instead, the lender will deduct it from your loan amount.
Since personal loans are typically unsecured loans, you won’t need collateral to apply for one. Instead, you need a good credit score and a consistent and solid credit history.
However, some lenders offer secured loans if you have bad credit or want to qualify for lower rates. Secured personal loans usually use your car or some other valuable property as collateral.
Personal loans can generally be used for just about any purpose, and fast personal loans can give you funding within 24 hours. Here are a few of the 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
You can use a debt consolidation loan to pay off any current loans by combining your various debt into a single loan. This may be advantageous to some borrowers: It could save you money on interest, make your monthly payments easier to track and help you pay off debt faster.
Since debt consolidation loans are a type of personal loan, they are generally unsecured and come with fixed interest rates. However, there are debt consolidation pros and cons to consider.
A debt consolidation loan may not be best for those with bad credit, as it may not be worth it if you can’t obtain a lower APR. To find out if this type of credit 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 and allows you to purchase a home and build equity. There are many types of mortgage loans — conventional, FHA and VA, to name a few — all of which depend on factors like your background and income.
Most mortgages loans are 10, 15, 20 or 30 years long, though you may also find longer or shorter terms. They can come with fixed or variable interest rates.
Mortgages are also secured loans, meaning the home you purchase will serve as collateral while you repay it. Thus, if you’re unable to repay your mortgage, you could lose your home in the process.
Home equity loan
A home equity loan, sometimes referred to as a “second mortgage,” allows borrowers to take advantage of the equity they’ve built into their home since buying it.
You can typically borrow a loan-to-value ratio (LTV) of up to 85%, though this may vary by lender. This means you can take out up to 85% of your home’s value.
Like a mortgage, home equity loans are secured by your home, so you’ll want to keep up 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 those who plan to pursue a post-secondary education.
Since some young people who want to continue their education haven’t built up much credit, when you apply for a student loan, you may have to use a trusted loved one — like a parent — as a student loan cosigner.
These types of loans are typically unsecured and can cover expenses ranging from room and board, books and tuition. They can come with fixed or variable interest rates.
This type of debt can be split into two groups: private and federal student loans. As the names imply, the former are originated by private companies, while the latter is funded by the federal government.
Auto loan
Auto loans are a type of debt that allows you to purchase a new or used vehicle, which can mean anything from a truck to an RV.
Generally, auto loans are secured by the vehicle you purchased. Car loans come with fixed rates with repayment terms that can range from 12 to 84 months.
While most auto loans are secured by the vehicle you’re purchasing as collateral, some lenders also offer unsecured car loans, though you’ll need good to excellent credit to access them.
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 are a type of credit that 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 even offer SBA loans backed by the Small Business Administration (SBA); these can be as large as $5 million.
Business loans typically require collateral, but that isn’t the only factor lenders take into account. When you go through the process of how to get a business loan, creditors will also consider your business credit score, how long you’ve had your company, your cash flow, debt-to-equity ratio and working capital.
Credit builder loan
Credit builder loans are a type of loan 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, the loan amount is stored in a secured bank account that you can only access once you pay off the loan. In this way, your loan acts as collateral.
Building credit from scratch can take time, but the promise of receiving your loan funds after it’s paid off may serve as a good motivator for some borrowers.
However, credit builder loans aren’t very common, though you may have more luck finding one at a small financial institute, like a credit union.
Payday loan
With amounts typically up to $500, payday loans are considered a predatory type of lending due to high fees. These fees can equate to an APR of up to 400%. In that case, you’d pay more than $75 to borrow $500 for two weeks.
Combined with 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 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, instead 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.
What to consider with different types of loans
No matter what type of loan it is, taking on new debt can be overwhelming. There are many factors to consider before signing your name on that dotted line. Overlooking certain details can cost you more money in the long run.
- Credit scores: Before applying for any type of loan, it’s important to check your credit scores and reports first. Your credit scores — the most common of which are FICO Score and VantageScore — will set the tone for what lenders you may qualify with and what APRs you may receive.
- Loan purpose: You can use a personal loan for almost anything, but different loan uses generally have different rates. A home improvement loan may have a lower rate than a wedding loan, for instance. Loans with specific purposes, like mortgages and auto loans, may require that you present the asset you plan to purchase with the money.
- APRs: This is how much it will cost you to take out a loan, including interest rates and fees. A good credit score and a strong credit profile can help you access lower APRs which, in turn, allows you to spend less money on the loan.
- Loan terms: Your loan term (or the length of time you have to pay your loan) has an impact on APRs. Typically, longer loan terms mean lower monthly payments but more total interest. Short repayment terms often come with lower APRs and higher monthly payments but less total interest.
- Borrowing limits: How much you’re allowed to borrow will depend on factors like your income, how you plan to use the loan and your credit history. If you have bad credit, you may have a hard time getting a large loan amount.
- Secured versus unsecured loans: This is an important distinction to keep in mind — it can impact your APR, as well as the outcome of defaulting on a loan. When considering secured versus unsecured loans, the former tend to have lower APRs because they’re less risky for lenders due to collateral. However, if you default on a secured personal loan, your lender can seize your collateral, which your lender can’t do with an unsecured personal loan.
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