A Simple Guide to 5 Popular Types of Loans

A Simple Guide to 5 Popular Types of Loans
Aaron Crowe
By: Aaron Crowe
Posted: May 19, 2015
BadCredit.org's popular "How-To" series is for those who seek to improve, rebuild or better understand their subprime credit rating.

About one in 10 Americans are considered “credit invisible” because they don’t have a credit record, according to the Consumer Financial Protection Bureau.

Having a diversity of credit can help consumers who don’t have much other information to base a credit score on — after all, diversity of credit determines 10 percent of an individual’s FICO credit score.

Some loans such as home loans and student loans are some of the most common because they’re often for large amounts of money that people don’t have on hand. But there are other types of loans that may not be as much of a financial burden as a mortgage or loan to attend college.

However, they can still improve a credit score if they’re paid on time. If you’re looking for some temporary cash or want to diversify your credit profile, here are five other common types of loans:

1. Auto loans

Most people need to borrow money to buy a new or used car, which can take years to pay off.

Auto loans

There has been a rise in subprime auto lending over the past several months.

An auto loan can be financed through a bank, credit union, car dealership or home equity loan, among other methods. A bank loan will typically have the lowest interest rate, as will credit unions, while car dealers may have higher terms.

Some auto dealers offer manufacturer-sponsored, low-rate or incentive programs to buyers. The programs may be limited to certain vehicles or require a larger down payment or shorter contract such as 36 or 48 months, according to the Federal Trade Commission. A strong credit rating may be required to qualify.

A simple interest loan is the most common type of financing for a car loan. The interest rate is based on the outstanding balance, similar to a credit card. Borrowers can save on interest by paying more than the monthly payment.

A car loan is a secured loan, meaning the vehicle is collateral on the debt. If you don’t make payments, the lender can seize the vehicle.

If you’re looking to finance a new car, there are lenders willing to help.

2. Personal loans

Banks offer personal loans that are unsecured — this means collateral isn’t needed, only a borrower’s creditworthiness. High credit scores are preferred.

The money from a personal loan can be used for anything, such as paying off bills to buying a TV. Loans of up to a few thousand dollars are typical and are repaid within two years.

Interest rates vary from around 9 percent to 12 percent, and as of April 7 an average 24-month personal loan at a commercial bank was 9.85 percent, according to the Federal Reserve.

Some form of income verification is often needed by the lender, and proof of assets worth at least as much as the amount being borrowed may also be required.

If you’re looking for a personal loan, these lenders work directly with people who have bad credit.

3. Credit cards

Credit Cards

A credit card is one of the most popular types of loans used in the U.S.

A credit card is essentially a loan with the understanding that it will be repaid at a later date. Most merchants accept credit cards, making them an easy loan to use.

The interest rates on balances that aren’t paid in full every month can be upward of 20 percent per year. Credit cards can easily add up to more debt if they’re used too often and not paid off in full each month.

Although many credit cards are designed for people with good or excellent credit, several financial institutions offer cards to subprime borrowers as well.

4. Cash advances

These are short-term loans offered by credit card companies, short-term lenders such as payday lenders and tax-preparation companies that offer money against an expected refund from the IRS.

Cash advances are a way to get money now against future income. Payday loans are typically used by consumers who need money until their next paycheck arrives.

The loans are usually easy to get, are for $500 or less and are typically due on the borrower’s next payday. The finance charge can range from $10 to $30 per every $100 borrowed, equating to an annual percentage rate of almost 400 percent (or more in some cases), according to the CFPB.

As a frame of reference, APRs on credit cards range from 12 to 30 percent. Payday loans and other cash advances are regularly considered one of the last alternatives for getting a loan.

5. Small business loan

The Small Business Administration (SBA) or your local bank are the typical lenders to would-be entrepreneurs seeking a small business loan.

A business plan and a personal guarantee for the loan will be required. Loan terms vary but typically require repayment anywhere from five to 25 years. Some loans have variable rates.

Whatever type of loan you choose to apply for, remember to read the contract and seek legal advice if you don’t understand the terms. A loan can help you establish a credit record, but if you want it to help lead to a higher credit score, be sure you can afford the payments before signing the agreement.

Photo credits: quickloans.com, bankingsense.com, rollingout.com