What Are the Different Types of Loans and Credit?
There are a lot of different types of loans and credit available to individuals today—so many that it can feel overwhelming when you’re trying to determine the best way to borrow money.
To make it easier to select the right loan option for you, we’ll describe how seven common loan types work. We’ll also spell out their key characteristics, including how much you can borrow, and how the money is repaid.
Let’s start with a few personal finance definitions. Loans can generally be categorized into two buckets, based on whether collateral is involved:
• An unsecured loan is not backed by an asset. This means there is no collateral—like a house, car or other valuable item—for the lender to seize if the borrower stops making payments.
• A secured loan, as you might have guessed, is backed by an asset. If you stop making payments on the loan, the lender can seize the asset—known as repossession or foreclosure.
Common types of unsecured loans include:
• How does it work? You can apply for a loan from a payday lender online or in person, with funds usually made available the same day.
• How much can you borrow? Payday loans range from $100 to $1,000, depending on the state.
• What are the costs and how do you repay it? Lenders typically charge a fixed, flat fee based on the amount borrowed. You have until your next payday to pay off the amount borrowed plus the fee—all at once.
Personal installment loan
• How does it work? You can apply for a personal installment loan from an online lender, bank or credit union. Lenders will normally check your credit as part of the application process. If you’re approved, the money is usually available within a few business days—or sometimes as soon as the next business day. You can use the money for a variety of personal reasons, such as covering a financial emergency or making home improvements.
• How much can you borrow? Loans range from a few hundred dollars to several thousand dollars, depending on the lender.
• What are the costs and how do you repay it? The loan will have a fixed interest rate and a pre-determined length, anywhere from a few months to a few years. You’ll make regularly scheduled payments, usually biweekly or monthly. Each payment will typically be the same amount.
• How does it work? Student loans enable you to borrow money to cover the costs of education. You can apply for a student loan from a government program or a private institution, like a bank or credit union. Some lenders will check your credit history.
• How much can you borrow? It depends on the type of loan. Federal Perkins Loans, for example, are capped at $5,500 per year for undergraduate students. Private lenders look at several things to determine how much they’re willing to lend you, including your credit history (or your co-signer’s history) and the cost of tuition.
• What are the costs and how do you repay it? Student loans often have lower interest rates than other types of loans. They generally have fixed interest rates and a set maturity date (typically 10 years), so your monthly payments will be the same amount. Many student loans offer borrower-friendly features, like the ability to wait until you’re out of school to start making payments or the option to postpone payments if you’re having financial trouble.
• How does it work? With a credit card, you can continually make purchases (i.e. borrow money) until you reach your credit limit. Because you can continuously borrow and make payments, credit cards are considered “revolving” debt.
• How much can you borrow? When you apply for a credit card, the issuing company will check your credit history to determine your annual percentage rate (APR) and credit limit. Credit limits can range from a few hundred to tens of thousands of dollars, and APRs can range from about 12% to more than 20%. A better credit score will usually land you a higher limit and lower APR.
• What are the costs and how do you repay it? If you pay back the balance in full each month, you won’t be charged interest. If you don’t pay back the full balance, you’ll be charged interest on the remaining amount. Credit card interest compounds, so you’ll pay more interest the longer you wait to pay.
Common types of secured loans include:
• How does it work? Mortgages used to purchase a home, and the home serves as collateral. You can apply for a mortgage from an online lender, bank or credit union. The government also manages programs which play a role in the mortgage process. If you stop making payments on your mortgage, the lender can foreclose on your home and sell it to try to recoup the unpaid debt.
• How much can you borrow? The size of your mortgage and the interest rate will be based on several factors, including your credit history, other debts, income, and the type of house you’re buying.
• What are the costs and how do you repay it? You’ll make monthly payments on your mortgage to cover the principal and interest. Some mortgages have variable interest rates, while others are fixed. Mortgage lengths typically vary from five to 30 years.
• How does it work? Auto loans are very similar to mortgages—except you’re using the borrowed money to buy a new or used car instead of a house. The car serves as collateral. You can apply for an auto loan from an online lender, bank or credit union; car dealerships also offer financing. If you stop making payments on your auto loan, the lender can repossess (take away) your car.
• How much can you borrow? Much like a mortgage, the size of your auto loan and the interest rate will be based factors like your credit history, other debts, income, and the type of car you’re buying.
• What are the costs and how do you repay it? You’ll make monthly payments on the auto loan to cover the principal and interest. Most car loans have fixed interest rates and a pre-determined maturity date—usually between three and five years—so your monthly payments will be the same.
Auto title or pawn loan
• How does it work? An auto title loan is a type of short-term secured loan that uses your car title as collateral. If you own your car outright, you can drive away with cash after an appraisal. The lender keeps your car title until you repay the loan. A pawn loan works in a similar way, but with a different object of value (for example, jewelry) put up as collateral. These loans are typically for a few weeks to a few months. If you can’t pay back the borrowed money and fees at the end of the period, the lender can repossess your car, or keep whatever item you left as collateral.
• How much can you borrow? It depends how much your collateral is worth. Auto title loans, for example, are usually for an amount that is 25% to 50% of the car’s value.
• What are the costs and how do you repay it? Auto title and pawn lenders often charge financing fees of up 25% per month, which equals an APR of at least 300%. There are often other fees to pay, too, like appraisal or storage fees. At the end of the period, you’ll have to pay back the borrowed amount plus all fees and charges in one lump sum.
RISE offers online personal installment loans that let you borrow on your own terms (state restrictions apply) —you borrow what you need, when you need it. Plus, RISE helps you rebuild or improve your credit with free credit monitoring and financial tools designed to get you on track. Apply today and find out if you qualify within minutes.