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Personal Credit
Credit Cards
Home-Equity Credit
Home Equity Lines of credit
Credit Card Cash Advances
Small Business Loans
Personal Finance Loans
Understanding Different Loan Types
Select the option that is most suitable for your financial situation
By Glenn Curtis
Updated June 19, 2021
Review by Thomas Brock
The money you borrow is a great option for a variety of reasons, from financing an entrepreneur’s new venture to buying your partner an engagement rings. But with all of the different kinds of loans available what is the best one, and to what use? Below are the most common types of loans and how they work.
The most important takeaways
The personal loans and credit cards are characterized by higher interest rates, but do not require collateral.
Home-equity loans are low-interest, but the borrower’s home is used as collateral.
Cash advances typically come with high interest rates and transaction charges.
Personal Lending
Many banks, both online or in Main Street, offer personal loans and the money can be used to pay for everything from buying a brand-new 4K 3D smart television to paying off bills. It’s a costly method to borrow money, as the loan is unsecured, which means the borrower isn’t required to provide collateral that could be seized in case in the event of default, similar to the car loan or mortgage on a home. In general, a personal loan can be obtained in the range of a few hundred or several thousand dollars with repayment terms of two to five years.
For borrowing, you must have income verification, as well as evidence of assets that are worth at least as much as the amount being borrowed. The application typically is only a page or two in length. The decision to approve or deny the application is usually given within a couple of days.
The Best and Worst Rates
The median interest rate for a 24-month commercial bank loan was 10.21 percent in the fourth quarter of 2019, as per the Federal Reserve.1 However, interest rates could be more than three times the amount. Avant’s APRs range from 9.95 percent to 35.99%.2 The most favorable rates can only be obtained by those with outstanding credit ratings and significant assets. The worst rates must be endured by those who are left with no choice.
A personal loan is most likely the best option for those who need to get a modest amount of money and are certain they can repay it within a couple of years. An online personal loan calculator is a useful tool for determining the interest rate that is within your means.
Bank Loan vs. Bank Guarantee
An institution’s loan cannot be the equivalent of a bank guarantee. A bank may issue a guarantee as surety to a third party for one of their customers. If the customer fails to meet the contract with the third party, that party could require repayment from the institution.
The guarantee is usually an arrangement for a bank’s small-business clients. A business may be able to accept an offer from a contractor for instance, under the requirement that the contractor’s bank offers a payment guarantee in the case of default in the terms of their contract.
A personal loan might be best for those who have to borrow a modest amount and is confident of their capacity to repay it in a few years.
Credit Cards
When a person pays with a credit card it’s essentially equivalent to getting a small personal loan. If the amount is paid in full immediately, no interest is charged. If a portion of the debt remains unpaid the interest will be charged each month until it is paid off.
The average credit card interest rate carried a 16.88% APR at the close of the fourth quarter of 2019 according to Federal Reserve. This was a slight decrease from the second quarter of 2019 rate of 17.14 percent, but almost exactly where it was (16.86%) at the close of fourth-quarter 2018.3 Penalty rates for customers who do not make one payment, could get bumped even higher—for example up to 31.49 percent on at least two of HSBC’s Mastercards.4
Revolving Debt
The big difference between a credit card and a personal loan is that the credit card is a revolving loan. The card is governed by a credit limit and the owner can repeatedly borrow money up to the limit and then repay it over time.
Credit cards are very practical, but they also require discipline to stay away from overindulgence. The research has proven that consumers are more willing to spend when they use money instead of plastic. A short one-page application process is a easier way to secure the $5,000 or $10,000 worth of credit.
Home Equity Loans
Owners of their own home can take out loans against the equity accrued in the properties. This means that they can take out loans up to the amount that they actually own. If the mortgage is half is paid off, they can borrow half of the worth of the property or if the property has appreciated by 50%, they can borrow the entire amount. The difference between the house’s current fair market value and the balance due to the lender is what could be borrowed.
Low Rates, Bigger Risks
One advantage of the home-equity loan is that the rate of interest is far lower than for a personal loan. According to a study conducted by ValuePenguin.com The median rate of interest for a 15-year fixed-rate home equity loan in the month of Feb. 5, 2020 was 5.82%. In light of the changes made in the tax law of 2017, the Tax Cuts and Jobs Act that enacted in 2017, interest on a home equity loan is now only tax deductible if the money borrowed can be used «buy, build, or significantly improve the property of the taxpayer which is the collateral for the loan» according to the IRS.5
The biggest potential downside is that the house is an asset that is collateralized for the loan. The borrower can lose their house in the event of failure to pay the loan. The funds from the home equity loan can be used for any use, but they are often used to upgrade or expand the home.
If you are thinking about a home equity loan may be able to recall two lessons that the financial crisis of 2008-2009:
Home values could go down and up.
Employment is at risk in the economic downturn.
Home-Equity Lines of Credit (HELOCs)
The home-equity line of credit (HELOC) functions like a credit card but uses the home as collateral. The maximum credit amount is extended to the person who is borrowing. A HELOC can be utilized, repaid, and reused throughout the period the credit account stays in good standing, which usually is 10 to 20 years.
Similar to a traditional home equity loan it is possible that the interest will be tax-deductible. But unlike a regular home-equity loan the interest rate is not determined at the time the loan is accepted. As the borrower may be accessing the money at any time over a period of years The interest rate is typically variable. It could be tied to an underlying index, like that of the prime rate.
Good or Bad News
A variable rate of interest can be either good as well as bad. When there is a rise in rates, the cost of interest for outstanding balances will rise. Someone who takes out a loan to construct a new kitchen and then pays it back over a period of years, for instance, may be forced to pay more in interest than expected, just because the prime rate jumped.
There’s another potential downside. The lines of credit that are available can be huge, and the introductory rates very attractive. It is easy for people to fall the middle of their finances.
Cash Advances with Credit Card
Credit cards generally have an option to cash advance. Effectively, anyone who has credit card benefits from an unrevolving line of cash that can be accessed at any automated teller machine (ATM).
It is a very expensive option to take out a loan. For instance of interest rates, cash advances with the Fortiva credit card is 25.74 percent between 36% and 25.74%, depending on the credit score of your credit.6 Cash advances also come with a charge, which is typically equivalent to the range of 3%-5 percent of the loan amount or a minimum of $10. The worst part is that the cash advance is added to the balance on the credit card which is then able to accrue interest from month to month until it is paid off.
Other Sources
Cash advances can be obtained from different sources. For instance, tax preparation companies might provide advances on an anticipated Internal Revenue Service (IRS) tax refund. However, unless there’s a urgent need, there’s no reason to sacrifice a portion of your tax refund to get the money quicker.
Small Business Loans
Small business loans are available through the majority of banks and through the Small Business Administration (SBA). They are usually sought out by people setting up new businesses or expanding established ones.
These loans are only granted after the business owner has presented an official business plan for review. The conditions of the loan usually include a personal guarantee, meaning that the owner’s personal assets serve as collateral against default in repayment. Such loans generally extend for between five and 25 years. The interest rates can be negotiated.
The small business loan is a must for many, if not most young businesses. However, the process of creating a business plan and getting approval for it can be challenging. The SBA offers a variety of resources , both online and locally to help get businesses launched.
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Personal Loan Guide
Personal Loan: Definition, Types, and how to get one
1 of 33
Understanding Different Loan Types
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Unsecured Loan
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Signature Loan
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What is Peer-to-Peer (P2P) lending? What is its definition and how it works
5 of 33
What is a Payday Loan? How Does It Work, How to obtain One and legality
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Personal Loan Calculator
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Are Personal Loans Tax Deductible?
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Are Personal Loans considered to be income?
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Can personal loans be included in Bankruptcy?
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Can personal loans be transferred to Another Person?
11 of 33
What effect do personal loans have on your Credit Score
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What is an amortization schedule? How do I Calculate It Using Formula
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Personal Loan Interest Rates: How is a Personal Loan Calculated
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How do I apply for Personal Loans
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Best Personal Loans
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The Best Small Personal Loans
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Best Bank Loans
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Best Peer-to-Peer Lending
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personal loans
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Best Personal Loans Online
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Best loans for people with bad Credit
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The best loans for fair Credit
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best personal loans for good credit
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The Best Loans for Outstanding Credit
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Best emergency loans for bad Credit
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Credit Consolidation Loans for Bad Credit
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The Best Consolidation Debt Loans
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Best Home Improvement Loans
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Best Personal Loans With a Co-Signer
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Personal loans in contrast to. Credit Cards What’s the difference?
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Personal Loans vs. Car Loans: What’s the Difference?
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8 Ways to raise Cash Than Car Title Loans
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