In 2020, the average amount of consumer debt in the U.S. reached record levels. Consumer debt grew to just under $14.9 trillion after the economy plunged into a recession instigated by the coronavirus pandemic.
Taking on debt can be a necessary financial step for many Americans, and can even be used as a tool to generate income and build your net worth.
However, there are very real differences between the various types of loans available. Some of them might be advantageous to you while others might be financially damaging.
Let’s take a look at some of the most common ways that consumers can borrow money.
1. Personal Loans
You can use personal loans for pretty much anything. While you might see personal loans advertised for different specific purposes, such as travel loans, medical loans, or consolidation loans, they all function in the same way.
Most personal loans are unsecured, unlike home and auto loans. This means that there isn’t any collateral backing the loan. Instead, the lender chooses to loan you money based on your creditworthiness.
The range of interest rates for personal loans can vary widely. Ranging from 6% to 36%, the length of the loan term can range between one and seven years.
Though personal loans can be used for just about any purpose, they are best used as a vehicle to help improve your finances. Some good reasons for getting personal loans include:
- Debt consolidation
- Refinancing an existing loan
- Home improvement project
- Medical bills
Some people will also use personal loans for discretionary expenses like vacations and weddings.
While many personal loans are unsecured, there is such a thing as a secured personal loan. For this type of loan, you have to offer some form of collateral like a certificate of deposit or a car. This can be a good choice if you are hoping to get the lowest possible interest rate, as lenders find you less risky since you have an asset backing up the loan.
If you are planning on taking out a personal loan to consolidate high-interest credit card debt, you might consider whether a balance transfer credit card would be a better option. You can learn more about different types of credit cards here.
That being said, you’ll want to be careful with secured personal loans. If you default on the loan you run the risk of losing the asset that is serving as collateral.
If you are interested in taking out a personal loan, check out this SoFi promotional offer.
2. Mortgage Loans
Homes are pretty pricey these days, and most homebuyers don’t have hundreds of thousands of dollars in cash to buy their new home outright. In order to finance the purchase of a home, many homebuyers take out a mortgage loan.
When you take out a mortgage, you don’t technically own a home until you have paid it off in full. That being said, you are able to live in the house immediately after the closing of the sale even though the lender technically owns the home.
Mortgages are secured loans. The asset that backs the loan is the house itself. This means that if you fail to pay your mortgage, the lender can seize the property from you.
You can get mortgage loans with 10, 15, 20, or 30-year term lengths. The interest rates on mortgages vary over time and the terms offered to you will depend on your financial situation, including your credit score.
For many homeowners, paying off their mortgage is one of their biggest financial goals. If you’re wondering what to do once you’ve finally repaid your home loan, check out this article.
3. Home Equity Loans
If you are a homeowner and you are considering taking out a personal loan, you might look into the option of home equity loans. They are just as versatile as personal loans and can have lower interest rates. This is because they are secured loans with the borrower’s house as the collateral.
How much money you can borrow through this method depends on how much equity you have in the home. Equity refers to the difference between the worth of the home and the balance that is left on the mortgage.
Depending on the amount of equity you have in the home, you might be able to get a larger loan through a home equity loan than a personal loan.
Another product that is similar to a home equity loan is a home equity line of credit (HELOC). This is a line of credit rather than a loan that is also secured by your house, but it is different in that it functions more like a credit card rather than a lump sum loan.
With both home equity loans and HELOCs, defaulting can lead to foreclosure. For this reason, it’s essential that you only borrow the money you know you can repay following the agreed-upon schedule.
4. Student Loans
Student loans are loans to help people pay for education and costs that are related to education. This might include school tuition, textbooks, food, housing, transportation, and more.
This type of loan is not supposed to be used for expenses that aren’t related to education. However, how the money gets spent is not monitored by the lenders.
There are both federal student loans and private student loans. The APR for federal student loans is typically between 5% and 8% while the APR for private student loans is usually between 4% and 14%.
The payoff timeline is usually 10 years for student loans. However, in some cases, the length of the loan be up to 25 years.
Some people choose to refinance student loans to help pay off their loans faster, save money on interest, or get a lower monthly payment. Learn more about whether or not student loan refinancing from SoFi is worth it.
5. Auto Loans
Buying a new car can be a big purchase, and taking out an auto loan allows borrowers to pay off their new vehicle over a period of time. These are usually secured loans with the car being financed serving as the collateral. This means that nonpayment can result in the repossession of the car.
The rates you can get for auto loans depend on the length of the loan as well as whether the vehicle is used or new.
The APR for auto loans is usually between 3% and 7%. The timeline for payoff is typically between 24 and 72 months.
It’s worth mentioning that loans can be taken out for just about any type of vehicle. This includes boats, RVs, motorcycles, and aircrafts.
You can apply for auto loans from large national banks, credit unions, local banks, online lenders, and dealership financing. Whether you end up with a Wells Fargo auto loan or a loan through the dealership, you’ll want to shop around to find the best loan terms available to you.
6. Payday Loans
Payday loans are short-term loans that are typically for $500 or less. Before you start googling “payday loans near me,” though, you’ll want to understand that this is an extremely predatory form of lending. These loans must be paid back when you receive your next paycheck with interest.
The fees that are charged by payday loans online or in person are often equivalent to an outrageous interest rate, potentially charging you 400% APR or more.
These loans are secured by the next paycheck of the borrower. This means that these are some of the “loans for bad credit” that borrowers can pursue. However, taking out a payday loan should be avoided at all costs and it’s worth trying to find another avenue for borrowing if you can.
7. Pawn Shop Loans
Another way to borrow cash fast is with a pawn shop loan. This is not an unreasonable option if you are interested in borrowing a small amount of money without dealing with a credit check.
This can be a less risky way to borrow money quickly than a payday loan. If you are looking for a small bad credit loan, consider a pawn shop loan first.
You can get this type of loan by bringing an object of value into a pawn shop. This might be a piece of jewelry or an electronic device. You will then be able to put that object down as collateral and borrow money based on its value.
The terms of these loans are going to vary depending on the pawnshop. It’s worth understanding that the interest rate can be quite high. For this reason, you will want to read and understand the terms of the loan before signing on.
It’s also important to note that, within the terms of the loan, you typically have a certain period of time to repay the loan. If you don’t pay back the full amount of the loan within the specified time period, the item you pawned will be sold so they can recoup the loan amount. You might also have to pay additional fees either to renew your loan term or cover costs for insurance and storage.
8. Credit Card Cash Advances
Some of the credit cards you have might offer a cash advance option. This is money that you can borrow against the available balance of your card for a short amount of time.
You can take out a cash advance from credit cards that offer this from a bank or an ATM. While this can be a convenient option when you’re in a pinch and need some cash, it is a fairly expensive way to borrow money.
In fact, using a cash advance is one of the costliest ways to borrow money. There are a number of expenses associated with cash advances, which include cash advance fees, ATM or bank fees, and interest.
The interest on the loan can be expensive in two separate ways. Firstly, the rate that credit card companies charge for cash advances is typically a lot higher than the regular rate for purchases. Secondly, the interest rate usually begins accruing right away, as cash advances aren’t subject to the same grace period as purchases are.
9. Title Loans
If you are looking to borrow money and you already own your car, it’s possible to take out a car title loan. Usually, you can borrow somewhere between 25% and 50% of the value of the vehicle.
According to the Federal Trade Commission, the amounts of title loans usually range between $100 and $5,500. While this can be an emergency option to tap into when you have no other way to borrow money, it’s not an ideal type of loan. This is because the APRs are usually in the triple digits and your car is the collateral.
Title loans often have to be repaid within 15 or 30 days. If you aren’t able to pay back the loan, your car can be repossessed. When you are approved for a title loan, you will have to turn in the title of your vehicle until you have repaid the loan in full, including any fees.
10. Payday Alternative Loans
Some federal credit unions offer a short-term loan known as a payday alternative loan. These loan products are designed to be a more affordable option than the often predatory payday loan.
The loan amounts for payday alternative loans usually range between $200 and $1,000. The repayment terms are usually longer than payday loans, giving borrowers between one and six months to repay the loan amount.
In order to receive this type of loan, you will need to be a member of a federal credit union for a month before applying.
Understanding the Different Types of Loans Can Help You Make the Best Decision as a Borrower
Taking the time to learn the ins and outs of different types of loans might not be many people’s idea of a good time. However, it’s absolutely essential to know what your options are when you are considering borrowing money in one form or another. The type of loan you get will determine how much money you pay in interest, how long it takes you to pay off the loan, and whether or not an asset of yours is at risk if you default.
Are you looking to learn more about different loan options? If so, check out our library of resources.