Understanding the Basics: A Guide to 12 Different Types of Loans

Posted on April 04, 2023 by Kayla Harris

So you’re looking for a loan? That’s great! But which one should you choose? What’s the difference between a personal loan and a business loan? And what about that term “home equity”?

Don’t worry. 15M Finance is here to help. In this guide, we’ll walk you through the basics of different types of loans available, so that when you go to apply for your own, you know exactly what it is you’re getting into and what your options are.

How Do Loans Work?
Unsecured Loans vs. Secured loans
Fixed vs. Variable Rates
12 Types of Most Used Loans
What Type of Loan Has the Lowest Interest Rate?

How Do Loans Work?

Here is a quick overview to understanding how loans work:

You apply for a loan by filling out a loan application form, be it online or in store, and submit it.
After several minutes or at most one hour, you receive a loan approval decision.
If approved, the lender will then make an offer based on your ability to pay back the loan and their own risk tolerance level. If they are willing to take on more risk, they will offer a lower interest rate. If not, they will offer a higher one.
To understand how it works, you should know the components of your loan:
Principal is the original amount of money that is being borrowed. Loan term is the amount of time that the borrower has to repay the loan. Interest rate is the charge at which the amount of money owed increases, expressed in terms of an annual percentage rate (APR). Loan payments are the amount of money that must be paid every month or week to satisfy the terms of the loan.
Once the lender has made an offer and you have accepted it, a contract is drawn up between the two parties that states all their obligations.
Over the loan term, you have to pay back your principal plus interest. Many lenders use just daily interest which is calculated as follows: the annual percentage rate is divided to 365. Each monthly payment covers that month’s interest plus some of the principal. The remaining principal gets smaller, which means you are making progress on your loan repayment.

Unsecured Loans vs. Secured loans

When you’re in the market for a loan, it’s important to know the difference between unsecured and secured loans.

An unsecured loan doesn’t require collateral. They typically have a higher interest rate than secured loans and can be used for anything from buying a car to paying off debts.

A secured loan requires collateral in the form of an asset, such as real estate or a car. These types of loans tend to have lower interest rates than unsecured loans.

Fixed vs. Variable Rates

Fixed rate loans are financial products with a fixed interest charge for the entire term. It means that you know exactly how much your monthly payments will be each month, and you won’t have to worry about any changes in interest rates.

Fixed rates are great for borrowers who want to plan their finances in advance. Fixed rate loans don’t change their costs during the loan term and don’t affect the monthly payment.

Variable rate loans are loans where the interest changes over time based on market conditions. If market conditions improve and interest rates go down, then your loan’s terms will automatically adjust accordingly and lower your monthly payments. But they can also go up and increase the monthly installment.

12 Types of Most Used Loans

The world of loans is a big one, and it can be overwhelming to try to understand what you’re getting into. So here’s a list of the 12 most common types of loans:

1. Payday Loans

A payday loan is an unsecured loan that you repay in two or four weeks. It’s usually a short-term loan, often for about two weeks, that can help you get by until your next paycheck. The minimum loan term is $100 and the maximum reaches $1,000.

Payday loans are typically used as emergency funds or to cover unexpected expenses that arise throughout the year. They’re great for helping you pay off bills or other costs, but you should take care. If you don’t borrow payday loans responsibly, they may get you in a debt cycle and the default will stay on your credit report for 6 years.

2. Personal loans

A personal loan is a type of installment loan that can be used for more significant expenses. You can use it to pay off debts, buy a car or house, or just about anything else you need. A personal loan usually has a repayment period of anywhere from one year to seven years (or even longer), and the interest charge varies depending on the amount borrowed. However, it ranges from around 4% to 36%.

3. Installment Loans

Installment loans are a type of loan that you pay back in fixed monthly installments. Installment loans are usually taken out over periods of time (from 3 to 24 months). If you don’t make those payments on time, your lender can take legal action against you and get the money back. Also, the APR of these loans is much lower than a payday loan. It ranges between 6.99% and 35.99%. The maximum amount of installment loan is $5,000.

4. Auto Loans

Car loans are also a type of installment loan that allows you to purchase a car, truck, or other vehicle. They’re often used as an alternative to leasing, and they can help you get into a new or used vehicle with lower monthly installments than the other options. The maximum term is 36 months.

Dealerships often offer financing as part of their service package, especially if you’re purchasing a new vehicle. They’ll take care of all the paperwork and make sure that everything is taken care of in a timely manner.

The interest rates of car loans vary between 2.99% and 36.00%. They also may range based on used or new cars you’re buying or your credit score. The higher your credit score (up to 850), the lower the interest rate.

5. Student Loans

Student loans are money that you borrow to pay for your education. They can also be used to pay for vocational training or continuing education classes, such as graduate school or even a certificate program at a community college.

There are two types of these loans: federal student loans (issued by the government) and private student loans (issued by private lending companies).

6. Mortgage Loans

Mortgage loans are a type of real estate loan that helps you buy a house or other property. They’re different from personal loans because they’re secured by the property itself. If you don’t pay back the mortgage, the bank can take ownership of your home.

The rates of mortgage loans vary according to the type of loan. In general, there are two types of mortgage loans: conventional and government-insured.

Conventional mortgages have a fixed interest rate that does not change during the life of the loan. Government-insured mortgages have an adjustable interest charge that changes periodically based on an index such as the cost of living or prime rate.

7. Home Equity Loans

Home equity loans are secured personal loans that allow you to borrow money against the value of your home. The interest charge on home equity loans is usually lower than for other types of loans. It ranges between 6.24% and 11.08% and available loan amounts on the market are between $25,000 up to $500,000. If you don’t pay off the loan, the lender will likely come after you for the balance owed on the loan.

8. Credit-Builder Loans

Credit-builder loans are a type of home loan that helps you build credit history and prepare for a mortgage. If you’re new to the world of mortgages, or if your credit score isn’t where it needs to be, a credit-builder loan can help you bridge the gap between where you are now and where you want to be.

Credit-builder loans work by helping you establish a history of on-time payments with a lender. It might seem like an unnecessary step if you already have a long history of paying your bills on time, but sometimes even people with perfect payment histories need help building up their scores in order to qualify for certain loans. Most credit builder loans are small. The available loan amounts range from $300 to $1,000 and the repayment term—six to 24 months.

9. Debt Consolidation Loans

A debt consolidation loan is a way for people who are dealing with multiple payments on different credit cards or outstanding loans to combine them into one single monthly payment. In theory, this makes it easier for people to stay on top of their finances, repay the debts on small debts, shorten or extend the amount of time you’re in debt, or make a single loan payment per month. To qualify for a debt consolidation loan, you’ll need to have a good credit score and enough income.

10. Pawn Shop Loans

To get a pawn shop loan, you need to bring in some kind of collateral, which can be anything from jewelry to electronics to tools. The pawn shop will give you money based on the value of what you’re bringing in, and then they’ll hold onto it until you pay back the secured loan.

The average interest rate per month on a pawnshop loan is about 20% – 25%. It makes sense, because the borrower needs to repay the loan quickly (usually within 30 days).

11. Small Business Loans

Small business loans are a great way to help you get the money you need to start or grow your business. Small businesses account for 99.7% of all businesses in the United States, and they employ 55% of the American workforce.

Entrepreneurs may get small business loans from banks, credit unions, and online lenders. You may qualify whether your business is a sole proprietorship or limited liability company (LLC) or a smaller corporation.

The interest charges of a small business loan can vary widely based on the type of loan and lender. According to the Federal Reserve Bank of Kansas City, the average interest rate for all small business term loans in the first quarter of 2023 was 5.39%for fixed-rate loans and 6.25% for variable-rate loans.

12. Co-signed and Joint Loans

A co-signed loan is one that you take out with another person who is called your cosigner. They agree to make payments on the loan if you stop making payments. They are also responsible for any missed or late payments made by you.

A joint loan is one that you take out with another person, but it’s not cosigned by them. Instead, they become an equal partner in the loan. It means they have an ownership stake in it and can expect to share in any profits from the loan.

What Type of Loan Has the Lowest Interest Rate?

Interest rates are the cost of borrowing money, and they can vary widely depending on the type of loan you’re taking out. Here are some common types of loans that have lowest rates:

Mortgages – 4% APR
Auto loans – 7% APR
Student loans – 6% APR
Credit cards – 12% APR