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Consumers commonly take on loans to finance home purchases, education, debt consolidation and general living expenses. For the growing small business, loans are available for working capital, equipment, real estate, expansion, and inventory purposes. In short, there's a wide variety of options available on the loan market, so it's important to research what type of debt obligation will work for you. Below, you can find a breakdown of each loan type and how it will affect your finances.
- Different Types of Consumer Loans
- Small Business Loans
Consumer Loan Types
The most common consumer loans come in the form of installment loans. These types of loans are dispensed by a lender in one lump sum, and then paid back over time in what are usually monthly payments. The most popular consumer installment loan products are mortgages, student loans, auto loans and personal loans. In general, lenders use consumer's credit score and debt to income ratio to determine the interest rate and loan amount for which they are qualified.
Secured or unsecured?
|Mortgages||15 or 30 years||Secured|
|Student Loans||Varies depending on borrower's debt and post-grad income||Unsecured|
|Auto Loans||Usually up to $100,000||2 to 7 years||Typically secured|
|Personal Loans||Usually up to 10 years||Both|
Installment loans can come as either secured or unsecured. Secured loans are backed by collateral, meaning that the lender can seize the borrower's collateralized asset if the loan isn't paid back. Unsecured loans are not secured by collateral, and lenders have a more difficult time recouping their losses for these loans if a borrower defaults. In general, larger loans and specific purchase loans like mortgages and auto loans are secured.
Mortgages are used by consumers to finance home purchases. Because most homes cost much more than the average person makes in a year, mortgages are designed to make homebuying accessible by spreading out the cost over many years. The most common home loan is the 30 year fixed-rate mortgage. This loan is repaid in fixed monthly installments over the course of 30 years in a process called amortization. Mortgages with term lengths of 15 or 20 years are also offered, but are far less common—as their monthly payment is much higher than the 30 year variety.
Mortgage programs also differ depending on which agency sponsors them. There are three main types of mortgages: conventional mortgages, which are backed by Fannie Mae and Freddie Mac; FHA loans, which are designed for low income or credit poor individuals and are backed by the Federal Housing Administration; and VA loans, which are for veterans and are backed by the Department of Veterans Affairs. FHA loans are good for people who want to make a lower down payment, while conventional mortgages are more affordable for those who make a down payment over 20%.
|Mortgage Insurance||None||Upfront and annual premium for the life of the loan||Paid until 20% equity is reached|
|Minimum Down Payment||None required||3.5% of home value required||3% of home value for most qualified borrowers|
|Credit Score Minimum||Varies by applicant|
Most student loan borrowers opt to take out federal student loans, which have fixed interest rates and don't have to be repaid until a few months after graduation. The two main types of federal student loans are subsidized loans and unsubsidized loans. The subsidized version is meant for students with the highest financial need, as the government makes interest payments on the loan while the student is still in school.
Federal unsubsidized loans are available for the average student borrower regardless of financial situation. Undergraduate students who are still dependent on their parents are allowed to borrow up to $31,000 total over the course of their career, with a limit of $23,000 in unsubsidized loans. Federal loans have the same interest rate for all borrowers.
Due to the caps on federal loans, some students choose to take out loans with private companies. Private loans often offer interest rates that are slightly lower than for federal loans, though rates are dependent on each individual's financial situation. Student loans from private lenders can also be borrowed with a variable interest rate, meaning that interest payment goes up or down depending on the current interest rate of the market. Limits on private loans vary from lender to lender.
Personal loans are the most versatile loan type on the consumer lending market. While mortgages, car loans and student loans must be used for a specific purpose, personal loans can be borrowed for debt consolidation, day-to-day living expenses, vacations or credit building, among other things. The terms of personal loans vary as widely as their uses, though term lengths are generally under 10 years and the maximum amount is usually capped at $100,000.
A common use of a personal loan is to consolidate existing credit card debt. Credit card interest can quickly accumulate when the balance isn't paid off, so personal loans are often a more affordable way to pay down debt. Depending on lender, personal loans can either be secured or unsecured. Loans not secured by collateral have higher interest rates, as they're riskier for lenders to make.
Auto loans can be used to purchase either new or used vehicles. The term of an auto loan typically ranges from 24 months to 60 months, though longer loans with 72 or 84 months are becoming increasingly common. Most lenders limit the term lengths to 48 or 60 months for older car purchases, as used cars are riskier to finance. This is because car value generally declines over time, unlike home value. Accordingly, if the car being financed is also used as collateral, lenders need to make sure that it will be worth enough to cover their losses if the borrower defaults.
Because of the rapid depreciation of car value, shorter loan terms and larger down payments are most advisable for auto loans. For an older used car, it's quite easy for borrowers to find themselves "upside-down"—meaning that they owe more on their loan than their car is currently worth. To avoid this situation, it's important to not take out money with too long of a repayment schedule, and to evaluate how quickly your car will depreciate. The consequences of defaulting on a car loan can be severe, as many loan servicers will require that the loan is repaid even after default and asset forfeiture.
Small Business Loan Uses
Businesses use loans for many of the same reasons as consumers—to cover gaps in short term financing, to pay for daily expenses and to purchase property. Most small business loans can be used for general business expenses, but there are also specific business debt products like the commercial real estate loan, which is similar to the consumer's mortgage, and the business line of credit, which is like a credit card. There are more complex financing products like invoice factoring and merchant cash advances for businesses with particular needs.
Small business loans can be a helpful tool for owners looking to expand their inventory, buy new office space or otherwise scale or finance their business. The loan amounts for small businesses can range from a few thousand to over a million dollars. If you're considering taking on debt to finance your business, you should compare lenders and loan types to see whose loan program best fits your specific needs.
Most online lenders require that business owners have a minimum credit score around 500 to 600 and have been in business for a certain period of time, usually a year or two, in order to be eligible. Traditional banks like to see that borrowers have minimum credit scores of 680 or higher. The standards for being considered a small business vary by industry, though businesses with less than 500 employees usually fall into the small business category. You can find out how your business is classified here.