What is a Loan?

A loan is money that you borrow and must repay with interest. It’s a contractual promise between a borrower and a lender. The borrower agrees to repay a sum of money (generally with interest) in exchange for the lender giving another sum of money.

There are many different types of loans. So, there’s a loan for every situation. Finding the right loan is important to ensure you get the right product for your needs.

Let’s go over a few things first.

Unsecured and Secured Loans

Loans are either unsecured or secured.

Unsecured Loans

Unsecured loans require no collateral. Lenders approve unsecured loans based on income, credit history, and score. Your interest rate is usually dependent on your credit score, with higher rates for those deemed at higher risk. Examples of unsecured loans include personal loans, debt consolidation loans, student loans, and any-purpose loans.

Secured Loans

Secured loans require collateral. The collateral is tied to an asset that can be seized and sold in the event of loan default. Examples include auto loans tied to a vehicle, home loans tied to a house, or secured personal loans tied to a savings account. Rates are usually lower compared to unsecured loans.

Fixed or Variable Rate

With both loan types, the rates can be fixed or variable. A loan with a fixed rate will not have rates fluctuate. The rate and payments stay the same until the term and balance are paid off. The rates on a variable rate loan can rise and fall depending on market conditions but are usually capped.

What are Loans Used For?

You can take out a loan for a number of reasons. For instance, financing a home purchase, auto purchase, education, and debt consolidation or for business purposes.

Common Loan Types

Most loans are installment loans, a type of loan where you borrow a fixed amount of money at once and repay the loan over a set number of installments. The most common loan types are mortgages or home loans, student loans, auto loans, and personal loans (used for a variety of purposes). For approval, a lender will look at your credit score and debt-to-income ratio to determine your actual interest rate and loan amount.

Loan Description Typical Term Lengths Secured or unsecured
Home Loans
  • For home purchases (mortgages) or home equity loans.
15 or 30 years Secured
Student Loans
  • For higher education purposes.
  • Federal student loans or private student loans.
Varies based on the student loan. Unsecured
Auto Loans
  • For vehicle purchases.
2 to 7 years Secured
Personal Loans
  • For any purpose such as debt consolidation or large purchases.
Varies Unsecured

Home Loans

Home loans are mortgages or home equity loans. Mortgages are used to purchase homes and make affording a home possible by spreading the cost of a large purchase over many years. The most common mortgage term is 15 to 30 years. The mortgage is paid in fixed monthly installments.

A home equity loan or a second mortgage is a loan that places a security interest on the home. It can be used for home remodeling or any other purpose. Since the loan is collateralized with the home, the interest rates are lower than a personal loan.

Student Loans

Student loans are either federal or private loans. Federal student loans are subsidized or unsubsidized, have fixed interest rates, and don’t have to be repaid until after graduation.

Federal unsubsidized are available for most borrowers regardless of financial needs. On the other hand, federal subsidies are offered to students with the highest financial needs. There are federal caps on the number of student loans you can take. Additionally, federal student loans have benefits such as deferred payments, student loan forgiveness, and loan repayment plans.

Private student loans are offered by private lenders (banks and financing companies) and require underwriting that considers income, credit history, and cosigners for approval. Rates and loan amounts are based on the individual’s financial situation. Private loans can have fixed or variable rates. They may require payments while in school.

Additionally, student loan refinancing loans are available to consolidate your federal and or private loans into one manageable loan.

Personal Loans

A personal loan can be used for any purpose. Loan amounts and rates may depend on income, credit history, and debt-to-income ratio. You can use personal loans to finance a car, pay for a wedding, consolidate credit card debt, take a vacation, finance big-ticket appliances, and more. Terms for personal loans depend on the lender and can vary greatly.

Auto Loans

An auto loan is for a new or used vehicle purchase. Auto loan terms can vary from 24 to 60 months or more. Some lenders offer 72 to 84 months, but I’d recommend not spreading payments as long as the car value depreciates quickly. Auto loans are collateralized, and the car can be repossessed in the event of default.

Other types of loans

Many lenders offer other loan types, such as motorcycles, RVs, boats, payday, and more.

Where can you apply for a loan?

You can apply for a loan with your current bank or credit union or use a loan comparison website to get a pre-approval.

And check out your other loan options on the financial marketplace.