It’s always a good idea to save up money before making a large purchase. But in reality, that’s not always possible. That’s especially true for expenses like a college education, a car or a home, or even unexpected emergencies, like medical bills. When you can’t save money in advance, you can take out a loan. However, you’ll need to understand what types of loans to shop for because there are specific loans for certain purchases.
Major types of loans include personal loans, home loans, student loans, auto loans, and more. Each type of loan is helpful for different purposes and has different APR ranges, dollar amounts, and payoff timelines.
One thing most loan types have in common is that the borrower gets a lump sum upfront and pays it off over time. But there are even exceptions to this, such as credit-builder loans.
Types of Loans
- Personal loans
- Auto loans
- Student loans
- Mortgage loans
- Home equity loans
- Credit-builder loans
- Loans from friends/family
- Payday loans
- Auto title loans
- Pawn shop loans
Each type has a purpose in mind, so don’t just look for the one with the lowest interest rate and think that will be your final choice. Do some research and make sure the loan you choose is the one you actually need. Here is a little explainer for each loan.
Read More: What is Loan?
Different Types of Loans Explained
1. Personal Loans
Personal loans are among the most versatile types of loans, providing funds for pretty much any purpose, as long as it’s not illegal. Individual lenders may put restrictions on what their loans can be used for. For example, you generally can’t use a personal loan for a college education.
People commonly use personal loans for things like:
- Medical treatment
- Home renovations
- Debt consolidation
- Relocating to a new city
- Computers or other pricey electronics
Personal loans generally come in two forms: secured and unsecured. Secured loans are backed by collateral such as a savings account or a vehicle that a lender can take back if you don’t repay your full loan amount.
Unsecured loans, on the other hand, require no collateral and are backed by your signature alone, hence their alternate name: signature loans. Unsecured loans tend to be more expensive and require better credit because the lender takes on more risk.
Applying for a personal loan is easy, and typically can be done online through a bank, credit union, or online lender. Borrowers with excellent credit can qualify for the best personal loans, which come with low-interest rates and a range of repayment options.
However, the vast majority of personal loan providers offer loans with nearly limitless uses.
- Typical loan length: 12 to 60 months (sometimes 84+)
- Typical APR range: 6% to 36%
- Minimum loan amounts: $1,000 to $3,000
- Maximum loan amounts: $25,000 to $100,000
- Credit score required: 600 to 700 (average of 660)
- Collateral: Required for secured personal loans, not for unsecured loans
2. Auto Loans
Auto loans are a type of secured loan that you can use to buy a vehicle with repayment terms between three to seven years. In this case, the collateral for the loan is the vehicle itself. If you don’t pay, the lender will repossess the car.
You can typically get auto loans from credit unions, banks, online lenders, and even car dealerships. Some car dealerships have a financing department where they help you find the best loan from partner lenders.
Others operate as “buy-here-pay-here” lenders, where the dealership itself gives you the loan. These tend to be much more expensive, though.
Auto loan rates depend on both whether the vehicle is new or used and how long the loan lasts.
- Payoff timeline: 24 to 72 months
- APRs: 3% to 7%
- Credit score required: No minimum, but better scores get better terms
- Consequence for not repaying: Vehicle repossession
It’s also good to note that people can take out loans for pretty much any other type of vehicle, too, including boats, aircraft, and more.
3. Student Loans
Student loans are meant to pay for tuition, fees, and living expenses at accredited schools. This means that you generally can’t use student loans to pay for specific types of education, such as coding boot camps or informal classes.
There are two types of student loans: federal and private. You get federal student loans by filling out the Free Application for Federal Student Aid (FAFSA) and working with your school’s financial aid department.
Federal student loans generally come with more protections and benefits but charge slightly higher interest rates. Private student loans come with much fewer protections and benefits, but if your credit is good, you could qualify for better rates.
These loans are not supposed to be used for costs unrelated to school, though lenders do not monitor how the money gets spent.
- Payoff timeline: Usually 10 years, up to 25 for $30,000+ in some cases
- Sources: Private companies and the federal government
- APRs for federal student loans: 5% to 8%
- APRs for private student loans: 4% to 14%
Forgiveness: Possible after 10 years for public service works, 20 – 25 years for others
4. Mortgage Loans
Mortgages help you finance the purchase of a home, and there are many types of mortgages available. Banks and credit unions are common mortgage lenders; however, they may sell their loans to a federally-sponsored group like Fannie Mae or Freddie Mac if it’s a qualified mortgage.
Mortgage loans allow people to purchase a house without having enough money to pay for it all upfront. With a mortgage, the borrower can live in their home before they’ve paid the full price for it.
But the financial institution that issued the loan owns the house until the mortgage gets fully paid off. Mortgages are secured by the house in question.
- Length: 10, 15, 20 or 30 years
- APRs: 3% to 6%
- Credit score required: 620 for private, 580 for government-insured
- Sources: Private companies, government (FHA, VA, USDA)
5. Home Equity Loans
If you have equity in your home, you might be able to use a home equity loan, also known as a second mortgage. The equity you have in your home, the portion of your home that you own, and not the bank secures the loan.
You can typically borrow up to 85% of your home’s equity, which is paid out as a lump sum amount and repaid over five to 30 years.
To find out your home’s equity, simply subtract your mortgage balance from your home’s assessed value. For example, if you owe $150,000 on your mortgage and your home is worth $250,000, then your equity is $100,000.
Considering the 85% loan limit rule, and depending on your lender, you could potentially borrow up to $85,000 with $100,000 in equity. Depending on those values, a home equity loan may offer higher dollar amounts than personal loans.
- Loan lengths: 5 to 30 years
- APRs: 4% to 8%
- Credit score required: 680
- Collateral: borrower’s house
- Consequence for not paying: possible foreclosure
Home equity loans are similar to another product called home equity lines of credit (HELOC). Both are secured by your house. The difference is that a HELCO functions like a credit card, in that you can borrow up to a certain amount of money at any time, but aren’t obligated to borrow.
6. Credit-Builder Loans
Credit-builder loans are loans for people who don’t need to borrow money but want to establish or reestablish a history of timely payments and thus improve their credit. With a credit-builder loan, a financial institution puts money into a savings account (usually $300 to $1,000).
Then, the borrower pays this amount to the lender, plus interest at an APR of 6% to 16%, over 6 to 24 months. The lender reports payments to the credit bureaus each month, which helps to build the borrower’s credit history. In the end, the borrower gets access to the savings accounts with their funds.
Essentially, credit-builder loans work in the reverse of a normal loan. Instead of getting money and then paying it back in installments, the borrower pays money in installments and then gets a lump sum at the end.
7. Loans from Friends/Family
It’s possible to get a loan from a friend or family member rather than a financial institution. The major benefit to this is the potential for a low-interest rate, or even no interest, along with flexible repayment terms.
That, of course, depends on how generous the friend or family member is. But he or she will not have the power to pull the borrower’s credit report directly and is less likely to care about their credit score.
When borrowing from someone you know, it’s important to draw up and sign a loan agreement so that you can be held accountable for borrowing. And it’s important to take borrowing from this person as seriously as borrowing from a financial institution – doing otherwise would be a breach of trust.
8. Payday Loans
Payday loans are extremely predatory short-term loans that must be paid back with interest when the borrower receives their next paycheck. These loans are usually $500 or less, and the lender will often charge a fee equivalent to a 400%+ APR.
Because the loans are secured by the borrower’s upcoming paycheck, they are available to people who have bad credit. However, due to the enormously high costs, they are absolutely not worth pursuing.
9. Auto Title Loans
Auto title loans are loans secured by the document that grants legal ownership of a car. The borrower receives 25% to 50% of their car’s value upfront and then has to pay it back over a short term, usually only 15 to 30 days.
If they cannot pay in full within that period, it may be possible to “rollover” the loan for another month in exchange for additional fees.
The costs for an auto title loan can end up being as much as 25% of the loan amount. And if the borrower cannot pay off the loan, the lender can take their car. It’s definitely best to avoid these loans.
10. Pawn Shop Loans
Pawnshop loans are another type of loan we usually don’t recommend because they’re very expensive, have small loan limits, and require quick repayment.
To get a pawnshop loan, you’ll bring something of value to the pawnbroker, such as a power tool, a piece of jewelry, or a musical instrument.
The pawnbroker will assess the item, and if they offer you a loan, it’ll typically be worth 25% to 60% of the item’s resale value. You’ll receive a pawn ticket, which you’ll need when you return to repay the loan, typically within 30 days.
If you don’t return, or if you lose your ticket, the pawnbroker gets to keep your item to resell and recoup their money.
Loans vs. Other Types of Borrowing Options
Loans aren’t the only way to borrow. There are several other ways to finance a purchase, or otherwise afford it, such as a credit card, line of credit, or gifted funds.
- Loan vs. credit card: With a credit card, the cardholder is never obligated to borrow money and only pays interest on balances they carry from month to month. Plus, the card remains open indefinitely.
- Loan vs. line of credit: A line of credit is like a credit card without the physical card. The person who opens a line of credit only has to pay interest on what they borrow, and they aren’t obligated to borrow. However, some lines of credit may have a set “draw period” during which the borrower can take out money.
- Loan vs. gift: Loans require repayment, while gifts do not. Gifts are taxable, but it’s the person giving the gift who pays the tax. Gift givers only need to report gifts on their taxes if they give more than $15,000 to any individual person/place in a year (e.g., they can give gifts of $10,000 to multiple places without needing to report it). And they likely won’t have to actually pay tax on gifts of $15,000+ because everyone has a lifetime tax exemption on $11.4 million worth of gifts.
What Types of Loans Should I Choose?
Whenever you decide to borrow money whether it is to pay the bills or buy a luxury item – make sure you understand the agreement fully. Know what type of loan you’re receiving and whether it is tied to any collateral you own.
Also, familiarize yourself with your repayment terms: what your monthly obligation will be, how long you have to repay the loan, and the consequences of missing a payment. If any part of the agreement is unclear to you, don’t hesitate to ask for clarifications or adjustments.
Finally, be sure the loan repayments fit comfortably in your budget. If you over-extend yourself, the consequences can be severe.