America is a nation of borrowers. Think of all the different types of loans out there. Over 83 million Americans have at least one personal loan, collectively owing a record $120 billion. Add in mortgages, student loans, and auto loans, and this number bulges significantly.
If you’re looking to take out a loan, you’re not alone. And, for the record, loans aren’t a bad thing. They help you build credit and sometimes offer the only path to purchasing big-ticket items, such as cars and houses.
However, you need the right information before taking out a loan. Take a look at the different types of loans that you should be aware of before you borrow money.
5 Different Types of Loans to Know About Before Borrowing
There are different types of loans to choose from. Without adequate knowledge, you could end up making a poor choice. Continue reading for a comprehensive guide to the different types of loans you can borrow.
1. Unsecured Personal Loans
Unsecured personal loans are incredibly popular in the United States. It’s easy to see why. Lenders don’t need borrowers to specify a reason for borrowing the money.
- Want to fund a wedding?
- Need to snap up a kitchen appliance?
- Planning a home renovation project?
Whatever your reason, you will get an unsecured personal loan—as long as your credit meets the lender’s requirements and you can prove that you have the means to repay the loan (borrowers usually need to submit a paystub, business income statement, or social security checks). If you’re self-employed, you can use a paystub maker to generate paychecks.
Unsecured personal loans are called “unsecured” because lenders don’t need any form of collateral from you. They just rely on your ability to repay the loan to make a lending decision.
This loan is ideal for you if you have a regular job or an income-generating business. It’s also ideal for solving financial emergencies since approval decisions are made fairly quickly.
2. Secured Loans
Among these different types of loans are secured loans. Secured loans require borrowers to put down an asset as collateral. Sometimes the loan is used to purchase an asset, which also services as the collateral.
A common example of a secured loan is a mortgage. When you want to buy a house, you can either pay in cash or take out a mortgage. If you’re anything like the average American, you’ll go in for a mortgage. If your application goes through, the home you’re buying serves as the collateral. You will hold joint-ownership with the lender until you pay off the mortgage. If you default on the home loan, the lender can initiate foreclosure proceedings.
Another example of a secured loan is an auto loan. Over 107 million Americans rely on these loans to buy their rides. Like a mortgage, an auto loan is secured against the car you’re buying. If you default on it, the lender can repossess the car.
There’s also another type of secured loan, a title loan. This is for people who already own assets that have a title. For example, if you already own a car and need to borrow some money, you can use the car as collateral.
Unlike other types of secured loans, title loans charge higher interest rates. Research shows the annual percentage rate for these loans can be as high as 300 percent, and borrowers can incur about $1,200 in fees every year for a $1,000 title loan.
Clearly, a title loan is the kind of loan you need to avoid unless you’ve got no other option.
3. Payday Loans
Sometimes you just need money fast—the next hour kind of fast. Perhaps you’re in a healthcare emergency and need to pay hospital admission fees. Or your car has broken down in the middle of a highway and you need it towed.
This is when payday loans come into play (if you don’t have any savings that is…)
Payday loans are fast and convenient. As long as you have a paycheck, payday lenders will approve any amount that’s below your net salary. This is regardless of your credit score.
But that’s where the positives end…
- are the black sheep of the lending industry,
- charge sky-high interest rates, and are
- known to trap borrowers in debt cycles.
Look at this way. You earn $2,000 a month and $1,500-emergency crops up, so you take out a payday loan worth a similar amount, fully deductible from your next paycheck.
When your next paycheck comes in, you have about $500 to take you through the month. This isn’t enough, so you go in for another payday loan to keep you going. Rinse and repeat.
A payday loan should be a measure of last resort. And when it comes to it, stick to borrowing small amounts and find lenders who offer longer repayment terms. If you overstretch your paycheck with a payday loan, you’ll spiral into a debt cycle.
Related: How to Pay Off Payday Loans
4. Home Line of Credit
A home line of credit is available to borrowers who have positive equity in their homes.
- If you own your home outright, you’ll easily qualify for this line of credit.
- If you have a home loan but your loan balance is much less than the fair market value of the home, you can also secure the credit.
A home line of credit is like a credit card, really. A lender will approve you for a certain amount of money, which you can use whenever and however you wish. At the end of the billing cycle, you’ll need to pay what you’ve used up, along with the associated interest or fees.
5. Credit Card Cash Advance
Your credit card enables you to pay for goods and services—as long as the cost is within your limit.
But what if you want hard cash from your credit card? Ordinarily, you won’t be able to withdraw cash from an ATM, unless your issuer offers a cash advance service. This enables you to withdraw cash within your limit, at a fee or interest charge.
Credit card cash advances are ideal when you need small amounts of money fast. But again…it’s not the ideal situation.
Have Your Pick From These Types of Loans
Borrowing money is a common practice among both the have and have-nots. However, you shouldn’t go in for any loan just because you qualify. It’s important to choose a loan that’s ideal for your specific circumstances.
With this guide on the various types of loans, you now know what’s on offer in the lending market, as well as how to choose the right one for your needs. Was this helpful? Keep reading our blog for more financial tips and insights!
AUTHOR LaTia Longuemire
My name is LaTia Longuemire. I enjoy writing, singing, and cooking in my spare time. My passion is helping others. At this stage in my lifetime, I'm primarily focused on my children. They are everything that keeps my world spinning.