Types of Loans

5 Types of Loans to Consider and How They Work

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Everyone needs help at some point in their life. As much as you may not admit it, there are situations in life that leave no option but to seek financial help. Debt or certain types of loans, when misused, can be debilitating and hazardous for your financial health, causing harm to your plans. 

However, when used correctly, a loan can help you in numerous ways, like funding a new business, financing home improvement projects, getting an education, managing medical expenses, consolidating existing loans, buying a home, and tackling financial emergencies.

A loan is when you are given a sum of money in exchange for repayment of the principal amount over a set period of time, at a fixed interest rate. The lender, usually a financial institution, advances you a fixed amount of money. In return, you agree to a certain set of terms and conditions including collateral (in some cases), a repayment date, interest, and finance charges.

That said, the exact amount of money you can borrow and the interest rate you’ll be charged varies depending on your credit history, your personal situation, and the type of loan. With many different financing options available from banks, you’ll need to know which type of loan is best for your needs and circumstances. Below are five different types of loans to consider and how they work:

1. Unsecured Personal Loans

An unsecured personal loan is a type of loan that doesn’t require any asset or collateral to guarantee or secure the loan. Instead, the lender qualifies and approves the loan based on your credit history and income. If you have good credit, an unsecured personal loan will be easier to acquire. And the good thing is you can use the funds for almost any purpose, from starting a new business and financing a major purchase to consolidating debt.  

While unsecured personal loans are a little less risky for the borrower, they are riskier for lenders. This is why they attract higher interest rates than secured personal loans. However, this type of loan can help you clear your high-interest credit card debt sooner as it can offer a lower interest rate than a credit card (if you have a higher credit score).

Interest rates for unsecured loans typically range from 5 percent to 36 percent, depending on the borrower’s creditworthiness. If you decide an unsecured personal loan is a right step, take the time to shop around so you can find better loan terms, with monthly repayment and interest rates that are affordable for your budget.  In general, this type of loan might be best for a person with excellent credit. They also need to be sure to repay the loan within a couple of years. 

2. Secured Personal Loans

A secured personal loan can provide you with the extra funds you need for almost any purpose such as a car title loan. This can include paying for medical bills, financing a major purchase, consolidating debt, etc. To qualify for this type of loan, you must use some type of collateral. An example could be an asset, certificate of deposit, or savings account. If you default on the loan, the lender is at liberty to seize the asset. They also use it to cover a portion or all the loan balance.

Secured personal loans are a little less risky for lenders. This is because they have the right to take possession of the collateral if the borrower is unable to repay. As such, lenders may offer lower interest rates than unsecured loans. Moreover, they tend to be more flexible when it comes to credit score requirements. So, if your credit score isn’t that high and you don’t mind pledging collateral, a secured personal loan can be a good option for you. 


3. Reverse Mortgage Loans

Reverse mortgage loans allow senior homeowners to borrow money against the equity value of their residential property. A reverse mortgage loan doesn’t require the homeowner to sell their home or make monthly payments to the lender. This is unlike a regular mortgage loan, which is the type you can use to buy a home and make loan payments to the lender. Instead, the homeowner receives funds from the lender either as a line of credit, fixed monthly payment, or lump sum.

However, the loan becomes due as soon as the borrower neglects to maintain the home, sells the home, permanently moves out, or passes away. The lender determines the initial principal limit based on several factors. These factors include the borrower’s age, the home’s value, the lender’s margin, and current interest rates.

A reverse mortgage loan can be used to supplement retirement income, pay out-of-the medical expenses, or fund home repair costs. If you are a senior citizen looking for extra funds to cover your expenses, this type of loan can help you avoid high-interest lines of credit. Thereby, saving you money. You can learn more about reverse mortgage loans on Michael G. Branson’s blog.


4. Payday Loans

A payday loan is a short-term loan that allows you to borrow a small amount of money. This is usually a portion of your next paycheck and you repay it by your next payday. The lender extends high-interest credit based on your credit profile and income. No collateral is required for approval. These loans are also referred to as check advance loans, deferred deposit loans, and cash advance loans.

A payday loan can be helpful if you need emergency cash and don’t have access to cheaper lines of credit. Some states have banned payday loans. Those that allow payday loans regulate the lenders differently.

It’s best to stay away from payday loans as they charge high levels of interest. Especially if there’s a chance you won’t repay the loan immediately. However, if you decide to apply for one, take the time to shop around. Compare loan charges and interest rates before you borrow. Some lenders can charge borrowers up to 400 percent annual percentage yield (APR). 

5. Debt Consolidation Loans

A debt consolidation loan is a fixed-rate, unsecured personal loan that allows you to pay off or reduce your loan balances on multiple high-interest debts more easily. Some of the unsecured debts you can pay off using this type of loan include payday loans, medical expenses, credit card debt, and personal loans. So, if you are looking to eliminate or lower debt, streamline payment, lower your monthly payments, or improve your credit score, a debt consolidation loan would be a good option.

Keep in mind that this type of loan does not erase your original debt. However, it transfers your loans to either a different type of loan or lender. If you decide to apply for a debt consolidation loan, take the time to shop around for the best interest rates, loan terms, and type of personal loan.