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Loans are an invaluable financial tool to ensure that you have the funds you need when you need them. However, choosing the right type of loan is essential and it’s important to have a good understanding of what options are available to you.

This article looks at how different varieties of loans and credit function and what kinds of loans individuals and businesses can make use of. Find out now what kind of borrowing can work best for your situation.

How Do Loans Work?

A loan is simply a sum of money that is lent by one person to another. The amount given must be paid back either as a lump sum or in regular installments by the borrower. A percentage of interest is usually also charged on the lump sum that was borrowed.

Loans will usually fall into one of two main categories:

  • Secured loans: Those that are covered by collateral such as a house, car, or another asset, which can be repossessed if the debtor defaults on the loan principal. The debt can also be sold from one creditor to another under these agreements.

  • Unsecured loans: Those that are provided at the risk of the creditor, with no collateral promised. As a result, these types of debts are normally untradable.

Legal documentation is available to create records of the debts owed by the debtor to the creditor. Items such as loan agreements, promissory notes, and even IOUs are used regularly to accurately record, formalize, and legally enforce capital that’s been lent.

Create a Loan Agreement

Once the money has been repaid in full the lender can then formally release the obligation to pay the debt. Nevertheless, debts are sometimes released even if the full amount hasn’t been serviced, usually if the debtor has defaulted with no chance of repaying the money owed.

What About Credit?

Credit is another form of borrowing, which is usually provided on a more flexible basis for shorter-term lending. Instead of being provided a fixed amount of money, credit allows you to draw from a balance of money that is made available to you if you need it.

For example, overdrafts are a kind of credit. They can be used at any time as long as you have an agreement with your bank. The money borrowed will still usually be paid back with interest much like a loan.

Credit is usually given in two different ways:

  • Open-end credit: This is the kind of credit you’ll normally use when paying with a credit card or getting an overdraft. The money you can access is repaid monthly and can be used on a flexible basis.

  • Closed-end credit: Closed-end credit differs as it is usually lent for specific purposes for a fixed period of time. For example, being offered a credit agreement to buy a car or vehicle. It is only accessible if you have a high enough credit rating.

Five Common Types of Loan

There are many types of loans offered by financial institutions and banks. These will normally be designed to help finance a specific kind of asset purchase or activity and will usually have terms tailored to fit the necessities of the transaction.

Five of the most common types of loans you’ll encounter in the financial market are as follows.

Mortgages and Home Buying Loans

Mortgages are long-term loans that are given to help people and businesses purchase land and real estate. This is secured against the value of the property itself, creating a lien on the asset.

  • Term length: 15 - 30 years
  • Interest rate: 2% - 6%

Student Loans and Higher Education Financing

Student loans are given to individuals pursuing higher education, which can be paid back in the long-term. 2 kinds of student loans exist, federal loans which are provided by the US government, and private student loans which are provided by banks.

  • Term length: 10 - 25 years
  • Interest rate: 4% - 14%

Auto Loans and Vehicle Lending

Auto loans are medium-term loans that allow individuals to secure the funds necessary to buy a car. These can be used to finance any kind of vehicle purchase including boats, motorcycles, or trucks. Like mortgages, these are secured by a lien against the asset being bought.

  • Term length: 1 - 7 years
  • Interest rate: 3% - 6%

Small Business Loans and Other Start-up Options

Small business loans are provided by the federal government and other lenders. They can provide up to $5 million in funds to help entrepreneurs set up a company or expand on their current offering. The Small Business Administration is the main source of much of this funding and this kind of borrowing can be paid off in the medium-to-long term as required.

  • Term length: 5 - 25 years
  • Interest rate: 4% - 13%

Personal Loans

Personal loans come in all shapes and sizes. They are shorter-term in nature than other kinds of financing and can be used for almost any reason as long as the borrower can demonstrate a good enough credit score and/or by providing sufficient collateral.

  • Term length: 1 - 5 years
  • Interest rate: 6% - 36%

What Kind of Loan is Best?

There’s no one-size-fits-all kind of loan. The best kind of loan for you individually will always depend on your necessities for the money and your assets.

For example, if you need to borrow a few hundred dollars that can easily be repaid in a couple of weeks or months, an unsecured loan from a friend or family member might be a suitable option. If you’re starting a business and need substantial funds a bank loan might be necessary instead.

Loans are a big responsibility to manage. Choosing the right type of loan for your needs is essential, so always consider your position carefully before signing on the dotted line.

Loans are an invaluable financial tool to ensure that you have the funds you need when you need them. However, choosing the right type of loan is essential and it’s important to have a good understanding of what options are available to you.

This article looks at how different varieties of loans and credit function and what kinds of loans individuals and businesses can make use of. Find out now what kind of borrowing can work best for your situation.

How Do Loans Work?

A loan is simply a sum of money that is lent by one person to another. The amount given must be paid back either as a lump sum or in regular installments by the borrower. A percentage of interest is usually also charged on the lump sum that was borrowed.

Loans will usually fall into one of two main categories:

  • Secured loans: Those that are covered by collateral such as a house, car, or another asset, which can be repossessed if the debtor defaults on the loan principal. The debt can also be sold from one creditor to another under these agreements.

  • Unsecured loans: Those that are provided at the risk of the creditor, with no collateral promised. As a result, these types of debts are normally untradable.

Legal documentation is available to create records of the debts owed by the debtor to the creditor. Items such as loan agreements, promissory notes, and even IOUs are used regularly to accurately record, formalize, and legally enforce capital that’s been lent.

Create a Loan Agreement

Once the money has been repaid in full the lender can then formally release the obligation to pay the debt. Nevertheless, debts are sometimes released even if the full amount hasn’t been serviced, usually if the debtor has defaulted with no chance of repaying the money owed.

What About Credit?

Credit is another form of borrowing, which is usually provided on a more flexible basis for shorter-term lending. Instead of being provided a fixed amount of money, credit allows you to draw from a balance of money that is made available to you if you need it.

For example, overdrafts are a kind of credit. They can be used at any time as long as you have an agreement with your bank. The money borrowed will still usually be paid back with interest much like a loan.

Credit is usually given in two different ways:

  • Open-end credit: This is the kind of credit you’ll normally use when paying with a credit card or getting an overdraft. The money you can access is repaid monthly and can be used on a flexible basis.

  • Closed-end credit: Closed-end credit differs as it is usually lent for specific purposes for a fixed period of time. For example, being offered a credit agreement to buy a car or vehicle. It is only accessible if you have a high enough credit rating.

Five Common Types of Loan

There are many types of loans offered by financial institutions and banks. These will normally be designed to help finance a specific kind of asset purchase or activity and will usually have terms tailored to fit the necessities of the transaction.

Five of the most common types of loans you’ll encounter in the financial market are as follows.

Mortgages and Home Buying Loans

Mortgages are long-term loans that are given to help people and businesses purchase land and real estate. This is secured against the value of the property itself, creating a lien on the asset.

  • Term length: 15 - 30 years
  • Interest rate: 2% - 6%

Student Loans and Higher Education Financing

Student loans are given to individuals pursuing higher education, which can be paid back in the long-term. 2 kinds of student loans exist, federal loans which are provided by the US government, and private student loans which are provided by banks.

  • Term length: 10 - 25 years
  • Interest rate: 4% - 14%

Auto Loans and Vehicle Lending

Auto loans are medium-term loans that allow individuals to secure the funds necessary to buy a car. These can be used to finance any kind of vehicle purchase including boats, motorcycles, or trucks. Like mortgages, these are secured by a lien against the asset being bought.

  • Term length: 1 - 7 years
  • Interest rate: 3% - 6%

Small Business Loans and Other Start-up Options

Small business loans are provided by the federal government and other lenders. They can provide up to $5 million in funds to help entrepreneurs set up a company or expand on their current offering. The Small Business Administration is the main source of much of this funding and this kind of borrowing can be paid off in the medium-to-long term as required.

  • Term length: 5 - 25 years
  • Interest rate: 4% - 13%

Personal Loans

Personal loans come in all shapes and sizes. They are shorter-term in nature than other kinds of financing and can be used for almost any reason as long as the borrower can demonstrate a good enough credit score and/or by providing sufficient collateral.

  • Term length: 1 - 5 years
  • Interest rate: 6% - 36%

What Kind of Loan is Best?

There’s no one-size-fits-all kind of loan. The best kind of loan for you individually will always depend on your necessities for the money and your assets.

For example, if you need to borrow a few hundred dollars that can easily be repaid in a couple of weeks or months, an unsecured loan from a friend or family member might be a suitable option. If you’re starting a business and need substantial funds a bank loan might be necessary instead.

Loans are a big responsibility to manage. Choosing the right type of loan for your needs is essential, so always consider your position carefully before signing on the dotted line.