5 Common Types of Loans and Their Uses

When it comes to financing, there are many different types of loans available. Loans can help you unlock quick funding to meet your life goals without anything holding you back. 

Whether you are looking to consolidate debt, purchase a car, pay off an emergency expense, repair your house, or meet your immediate cash needs, there’s a loan available for all purposes. 

In this guide, we will explain the 5 most common types of loans so you can choose the right loan according to your needs, goals, and financial situation. So read on to learn everything there is to know about each type of loan.

5 Common Types of Loans Explained

Here are the 5 different types of loans offered by banks, credit unions, online lenders, and other financial institutions:

1. Mortgage Loan

A mortgage loan is designed to help you purchase houses and build equity. It is a secured loan where the house you purchase is considered as collateral until the loan is completely paid off.

Mortgage loans offer the largest sum of money that you can borrow from a lender. They are typically up to 30 years long and come with fixed or variable interest rates.

There are multiple types of mortgage loans, including FHA, conventional, high-balance, fixed-rate, and adjustable-rate mortgages. You can apply for the right mortgage loan according to your preferences, income, and credit history. Do note that if you default on your mortgage, you will lose your home. 

2. Auto Loan

An auto loan is a secured loan that is designed to help you buy new or used vehicles. The vehicle you purchase is declared as the collateral. With an auto loan, you can purchase any vehicle ranging from a car to a recreational vehicle (RV). 

Auto loans come with fixed interest rates and have repayment terms of up to 7 years. Their interest rates are generally lower compared to personal loans, making them a more cost-effective financing option for vehicle purchases.

However, some lenders also offer unsecured auto loans to borrowers with excellent credit scores. Look around and compare multiple lenders to choose the right auto loan for you. 

3. Personal Loan

Personal loans are unsecured loans offered by lenders in the form of a lump sum payment. They come with a fixed annual percentage rate (APR) and monthly payment. You can use these loans for just about anything, including debt consolidation, medical bills, home improvement, or emergency expenses.

Since personal loans are unsecured, the interest rates are generally higher than secured loans. You also don’t need to declare any collateral when applying for a personal loan. 

In order to get a personal loan, you will need a good credit score and a strong credit history. However, some lenders also offer bad credit loans at high rates. 

There’s also an origination fee associated with personal loans, which is to cover the documentation charges. However, not every lender requires it.

4. Student Loan

Student loans are unsecured loans designed to offer financing for post-graduate education. They can cover nearly all of your college expenses, including tuition, books, and accommodation. 

Student loans are offered by both the federal government and private companies. Federal student loans have a repayment term of up to 30 years. On the other hand, private student loans come with repayment terms of up to 25 years. 

If you have not built any credit, you may need a cosigner to apply for a student loan. Student loans are unsecured and come with both fixed or variable rates. 

5. Home Equity Loan

Also known as a second mortgage, home equity loans allow people to use the equity they have built into their home as collateral to borrow money. The equity is calculated by subtracting the outstanding balance of your mortgage from your home’s current market value. 

For instance, if your house is worth $200,000 and you owe $150,000 on your mortgage, your equity is $50,000.

While it typically depends on the lender, you can borrow up to 85% of your property’s value with a home equity loan. You can use this loan for home improvement, debt consolidation, or to cover any other expenses. 

Home equity loans come with a fixed rate and have loan terms of up to 30 years. In order to qualify, you will need a good credit score, a low debt-to-income (DTI) ratio, and at least 15% equity in your home.

Frequently Asked Questions (FAQs)

1. What are the main types of loans?

Some of the most common types of loans include secured loans, unsecured loans, revolving credit, and installment loans.

2. How is interest calculated on a loan?

Interest on a loan can be fixed or variable. It is represented as a percentage of the loan amount and is calculated according to the principal amount, the current interest rate, and the repayment term.

3. How to apply for a loan?

To apply for any type of loan, you will need to complete and submit a loan application form to the lender. You will also need to submit supporting documents, such as your proof of income, identity proof, utility bills, and credit history.

4. What are secured and unsecured loans?

Secured loans such as an auto loan or a mortgage loan require collateral to mitigate the risk for the lender. Unsecured loans such as personal loans do not require any collateral, which is why they come with higher interest rates.

Bottom Line

So that’s all, folks! We hope this guide helps you understand the basics of the most common types of loans available. No matter which loan you choose according to your needs, make sure to consider the APR, the repayment term, the borrowing limit, and the loan’s purpose before you sign your name on the loan agreement.

Good luck!