By Dave Fleming : 19 September, 2020
From auto loans to personal loans and student loans to mortgages, there are plenty of options from which you can choose, and they all fit into different buckets.
If you find yourself in need of funds but aren’t sure how to pick from the many types of loans out there, here are a few ways to tell them apart.
Open-ended vs. closed-ended loans
Open-ended loans, such as credit cards, offer revolving credit, meaning debt can be added to the loan as needed. By comparison, loans for a predetermined amount, such as auto loans, are considered closed-ended.
Examples: personal lines of credit and credit cards
Open-ended loans offer you the chance to borrow as much or as little money as you want, up to a certain amount, and then pay back some or all of the funds monthly. There’s no end date for this type of loan; it’ll always be open for you.
The upside to an open-ended loan is that you’ll be able to use exactly as much money as you need when you need it up to the pre approved limit. This can come in handy if, say, you’re temporarily short on funds. The downside is that if you only make the minimum payments, the interest can add up.
Watch out for open-ended loans with a variable interest rate, which fluctuates depending on the market. This can add a sizable chunk of money to your payments if interest rates rise over the life of the loan. You can find more information on variable rates below.
Examples: auto loans, student loans, and mortgages
Closed-ended loans are probably what you think of when you imagine a traditional loan. You borrow money for a specific purpose, such as paying for a car or house, and then you make monthly payments until it’s paid off.
Closed-ended loans are installment loans. When you borrow money, you make payments in installments until the loan is paid in full. You might have a five-year car loan or a 30-year mortgage — both have endings.
Closed-ended loans are clear-cut since you know exactly how much you’ll borrow and when you’ll have it paid off. Once the loan is paid off, you’ve held up your end of the bargain. And if you need to borrow money, you’ll have to get another loan, which can be costly with establishment fees added in.
Fixed-rate vs. variable-rate loans
A variable rate is an interest that fluctuates over the life of a loan based on market conditions. A fixed rate means your interest rate never changes for the agreed fixed term, regardless of how the market plays out.
You usually have the opportunity to choose a fixed or variable rate, depending on the lender and the type of loan.
Examples: student loans, and some personal loans, auto loans, and mortgages
You can also get a fixed-rate mortgage, which means the interest rate won’t change for the duration of your agreed home loan term. This can be valuable when most interest rates are heading higher.
Examples: some private student loans, personal loans, auto loans, and mortgages
If you get a loan with variable interest, it means your payments fluctuate depending on an underlying index rate that tracks the market.
Secured vs. unsecured loans
When you apply for a secured loan, you offer up something as collateral if you can’t pay off your loan. For an unsecured loan, you don’t have to provide any security for the debt, which means that if you can’t pay it back, it will go into collections and will tank your credit score.
Examples: mortgages and car loans
When you take out a car loan or get a mortgage, you’re receiving a secured loan. It’s easier to get because the collateral you put up secures your loan.
If you fall behind on your payments, your car could get repossessed or your house could be foreclosed on. Secured loans typically have lower interest rates because if you can’t pay back your loan, lenders have a way of recovering at least some of the cost.
Example: most personal loans
Personal loans that you use for anything you’d like are usually unsecured loans. These don’t require any collateral and are based on your credit score and income. You can use the loan however you wish, but you might have a harder time getting one if your credit history isn’t great.
Because there isn’t any collateral, unsecured loans tend to have higher APRs and in many insatnces a cap on how much you can borrow.
Types of loans
There are many types of loans that fall into the categories described above. Here are a few common ones that you might use at one time or another.
1. Student loans
These loans are meant for educational expenses, though the borrower can choose how exactly to spend the funds. Government student loans are awarded to you based on your financial need.
If you don’t have enough money to pay for college even after Government student loans, you can take out private student loans, but make sure to compare lenders to see which offers the lowest interest rates and best repayment terms.
2. Auto loans
Whether you’re buying or leasing a car, an auto loan helps you pay for it if you can’t afford a full cash payment. They’re secured loans, which means if you don’t pay back your loan with minimum payments each month, your car could be repossessed.
Your interest rate depends on your credit score. If you don’t have great credit, you might need a cosigner for your auto loan.
Unless you can afford the entire cost of a home upfront, you’ll need a mortgage. It’s a type of secured loan that banks offer, usually with a low interest rate. If you can’t afford your mortgage payments and fall behind, you could lose your property.
4. Home equity loans
Home equity is the slice of your home’s value that is your’s outside of what you owe the bank. In other words, it’s the total value minus anything you owe on it to a bank or other creditor. Also known as a line of credit.
You can use a home equity loan for almost anything, but your home is used as security if you can’t pay back your loan. This means it could go into foreclosure if you fall behind on payments.
5. Personal loans
Personal loans can be a good option if you need cash. Whether you’re trying to pay off high-interest credit card debt or stay up to date on bills, you can use personal loans for many things. As with any financial decision, though, you’ll want to shop around and consider your decision carefully.
Unsecured personal loans are harder to get because they require a great credit score. Payday loans are considered personal loans, but they should be avoided since they are short-term, high-interest loans. If you can’t pay it back by your next payday, don’t get a payday loan.
6. Refinance and consolidation loans
If you have a lot of different student loans, you might look into refinancing or consolidating them. This allows you to streamline your debt into one easily managed monthly payment.
Consolidation takes all your applicable debt and makes it into one loan, generally at a weighted average interest rate. You can consolidate your federal student loans, for example.
Refinancing loans replaces one or more loans with a new one, often with a lower interest rate, a longer repayment term, or both. If you’re struggling to pay high-interest credit card debt or your mortgage, you might consider refinancing those loans.
Find a loan that’s the right fit for you
Now that you’re familiar with the different types of loans, you can go through all your options to find the one that fits your situation best.
From secured or unsecured to variable or fixed, there are plenty of choices. The next step is to compare lenders and other options to get good repayment terms for your budget and low interest rates.
If you need help, seek out an experienced professional mortgage broker who can help you quickly understand the jargon surrounding loans. There services are generally free as the lender pays their commission. Yes, most mortgage brokers these days also can help you with all kinds of loans including car and personal loans.