Loans 101: The different types of lending options explained

The financial industry offers a loan product for almost every need. The different types of lending options and list of loan products are so substantial that it’s nearly impossible to summarize the menu of loans in one article. When you’re searching for the right loan for your needs, where do you begin? And how do you find the best loan product when the list of options differs from lender to lender?

The loan you choose depends on a variety of factors. To find your best loan, you must consider your:

• Purpose for the loan (why you need the loan)
• Budget and ability to repay the loan
• Credit score/creditworthiness
• Financial need (urgent, future, etc.)

Let's take a more detailed look at each of these decision-deciding factors.

Know your budget when loan shopping

The first and arguably most important thing to do when looking for a loan is decide how much of a loan you need. Whether you're buying a house and looking for a mortgage, or taking out a personal loan to do a debt consolidation, figure out how much of a loan you need.

Taking out a loan that is larger than you need means that you may be paying more interest than you have to. And it's important also to remember that it’s okay if your purchase price is lower than the loan approval amount. If you want to shop below your budget, that's okay — it can truly be a matter of personal budget comfort.

Why is your credit score important?

Another thing you'll want to do early on in the process of getting a loan is understand what your credit score is. There are several different types of credit scores, but FICO® (one of the most popular types of credit scores) breaks down credit score into the following five ranges:

• Excellent — 800 to 850
• Very good — 740 to 799
• Good — 670 to 739
• Fair — 580 to 669
• Poor — 300 to 579

The higher your credit score, the more likely it is that you'll be approved for a loan, and if you are approved, the lower your interest rate will likely be. However, it's also important to understand that your credit score is not something that is fixed in stone. Instead, credit scores can change over time as your spending and credit habits change.

If you need money fast, some loans are ideal

Another thing to understand is that in terms of how quickly you can get your money, not all loans are created equal. Mortgages and home equity loans are on the slow side of the spectrum, while personal loans and credit card cash advances are usually much quicker. If you need your money quickly, make sure to choose a type of loan that will get you your money when you need it.

How to determine the loan type you need

Once you ask yourself why you need the loan, it can help you figure out which type of loan might be the right one.

Different loan products help finance different needs. Your lending options could include these loan products:

• Mortgage loans
• Personal loans
• Home equity loans
• Car loans
• Credit card cash advances 

Let's take a deeper look at each of these options:

Mortgage/home loans

Thinking about buying your first home? A home purchase is one of the biggest acquisitions any of us will make. There are several different kinds of mortgages available, but one of the most common is the 30-year mortgage. This type of mortgage spreads the cost of buying a home over 30 years. Interest rates on the 30-year mortgage are often roughly correlated to the yield on 10-year Treasury notes. 

With housing costs soaring in most parts of the country, it can feel like an impossible task to buy a home without a loan. Luckily, there is an easy way to quickly secure a mortgage through our sister company Rocket Mortgage®.

Personal loans

Personal loans can help fund almost anything. Whether you need help paying for your wedding or covering an emergency vet surgery for your pet, personal loans can help you out. 

Personal loans may be either secured or unsecured loans. Unsecured personal loans do not require any collateral to cover the loan amount. This means you are not putting any of your possessions at risk for this loan. Secured personal loans require collateral that is used to protect the lender in case you default on the loan. Collateral can include your car, or a certificate of deposit. If you fail to repay the loan, the lender can take possession of the collateral. Individuals with poor credit scores may be required to offer up collateral.

One of the key benefits of a personal loan is that it may offer lower annual percentage rates (APRs) or interest rates than your credit card. For this reason, a personal loan can help to consolidate your loans into a single, manageable payment.

Home equity loans

Home equity loans are secured loans based on the equity value of your home. Your home serves as the collateral for this type of loan. The equity is the difference between the estimated value of your home minus the amount you owe on the home. If your home is appraised for $220,000 and you owe $150,000 on your current mortgage, you have $70,000 in equity. This is the maximum amount you could borrow with a home equity loan. 

Home equity loans can offer lower interest rates than some other types of loans. Do not confuse home equity loans with a home equity line of credit (HELOC). A HELOC acts as a credit line; you only use what you need (and owe this principal back to the lender). You pay interest on the amount you spend from the credit line. If you only use $1,000 of your HELOC, you pay interest on this amount and pay back the borrowed amount (a bit like a credit card).

There are benefits and disadvantages to both options; while a HELOC offers flexibility, a home equity loan allows borrowers to tackle big expenses and debts and repay them at a lower interest rate over time. If you are looking to get a home equity loan, check out Rocket Mortgage, which offers home equity loans at competitive rates.

Auto loans

The cars you purchase over your lifetime can be big expenses. Cars can serve as your way to get to and from work and help get you around day to day, which makes them critical to your long-term financial success. Investing in a safe and reliable car also makes all the difference.

If you cannot afford to buy cars in cash, then auto financing can be a lifesaver. Typically, you will need to make a down payment to secure any type of car loan, which is one of the primary differences between personal loans and auto loans. The down payment helps offset the impact of vehicle depreciation. New cars depreciate just by driving them off of the dealership lot, and they lose 20% of their value the first year of ownership.

Insights from Kelley Blue Book have shown that the average price of a new car has rapidly climbed over the past several years. This means that the length of car loans has also evolved. In the past, a 5-year car loan was standard. Now a 6-year term is common. Because cars lose so much of their value the first year, it's important to put down a significant down payment when you buy a new car. If you put a 10% down payment on a new car, the balance on your loan could be higher than the car's value. This is known as being "underwater" or "upside down". If your car is totaled or you try to sell your car, the proceeds from the insurance company or from the sale might not be enough to pay off your loan in this scenario. If you think this might happen to you, you can look at purchasing gap insurance, which will make up the difference if needed.

As you research different types of car loans, you’ll find that both dealerships and financial institutions offer auto loans. Although it can be more convenient to secure a car loan through the dealership, it is usually more affordable to work with a separate bank or credit union. Auto loans are just one type of bank loan, but your bank may have other favorable options available to you.

Credit card cash advances

If you already have a credit card, you may be able to secure a cash advance. Some credit cards have cash advance terms set up for you to borrow against your available balance. 

In a similar fashion to credit cards, these advances can come with high interest rates and many fees. Do your research before choosing this option. Remember that if you need extra cash for an emergency expense, a personal loan may offer a lower interest rate and can be a viable option if you have a good credit score.

The bottom line: Securing the loan you need

Whatever your specific needs, there is a loan option out there for you. And as you search for the best loan option, also consider working to improve your credit score. When you have a good credit score, your rates will be lower and loans may be more affordable. One of the easiest ways to increase your credit score is by paying your bills on time. Your payment history accounts for 35% of your credit score. Lenders want to know that you pay your debts on time! 

Whether you need a mortgage to finance your first home purchase or a personal loan to fund your plans, you now know the basic terms for understanding your loan options. Now, pay it forward by sharing with friends and deciding the type of loan that works best for you!