Understanding Loans: The Differences Everyone Should Know About

You already know that a loan is a type of debt. Anything can be a loan – a car, a book – even time.

In financial terms, though, a loan has a very specific meaning and comprises certain features. It is the lending of money by individuals or organizations to other individuals or organizations on the understanding that the principal amount will eventually be repaid along with interest accrued.

Loans are used for different purposes. Individuals need loans to buy a house, a car or even just to meet general living expenses. Small businesses need them for equipment, expansion and working capital. That’s why if you’re thinking of applying for a loan, you’re going to come across a wide range of options. All the more reason to research thoroughly and choose carefully.

This article aims to give you an overview of the most popular types of loans and the different features they have to help you make an informed decision regarding the loan that’s right for you.

If you’re reading this, you’re probably looking for a consumer loan which is also an installment loan. Basically, the lender gives the borrower (you) a lump sum of money which you will pay back over time (usually in monthly installments), along with the interest charged. These are further divided into secured loans (backed by collateral such as a house which the lender can seize if the borrower fails to repay the loan) and unsecured loans (not secured by collateral).

The most common consumer loans include:


If you’re looking to buy a home but don’t have the money (most homes cost much more than the average person makes in a year), you will probably need a mortgage. A mortgage allows you to repay the cost of your home over a period of years. The terms, of course, depend on the lender. One thing to keep in mind is that the interest rates on mortgages can either be fixed or variable. It’s usually smarter to go with a fixed one because no matter how strong the economy is, you will probably be paying your mortgage for the next 30 years (at least) which is a long time to live with the  risk of interest rates blowing sky high.

Student loans

Student loans are designed to help students pay for university: including tuition, books, and living expenses. They usually differ from other loans in that they offer lower interest rates and defer the repayment while the students are still in school.

Personal loans

Personal loans are as versatile as they sound: you can use it for pretty much anything (unlike a student loan, for instance). People use it for debt consolidation, to cover daily living expenses, to go on holiday and even to build their credit score. As you’ve probably guessed, the terms and conditions of personal loans vary widely – and not all of them are created equal. It’s very easy to get duped into applying for a personal loan with misleading conditions so do your research carefully. Personal loans can be secured or unsecured. Unsecured loans tend to have a higher rate of interest because they’re riskier for lenders.

Auto loans

Auto loans are used to buy a vehicle – either new or used. Once again, the terms vary and depend on the vehicle in question. The value of a car usually declines over time (unlike a home) so it’s uncommon for the terms of a car loan to last longer than 60-80 months at the most. Usually, they’re much shorter. If you’re thinking of applying for a car loan, it might be a good idea to look at shorter loan terms and larger down payments.(Otherwise you will be paying for its current value even in the future.)

If you’re thinking of opening a small business, none of the above loans will be right for you. Instead, you’ll want to consider another option. The option below.

Small business loans

Businesses need money for the same reasons individuals do: to cover a short-term shortage, to pay for daily expenses or to buy property. Most small business loans can be used for general business expenses but some of them are more specific: like a commercial real estate loan or a business line of credit or even merchant cash advances. Like every other loan type, you will find a wide range of different offers. Make sure you compare lenders to see whose terms and conditions will help your business best before making a decision.

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Charlie J. Thompson
Charlie is a financial analyst turned writer His mission to provide general knowledge about the world of finance to help people from non-financial backgrounds make informed financial decisions.


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