If you’re going to embark on the process of taking out a loan, then you’re going to need to know what you’re getting into. Not all loans are created equal; some will have much more favourable terms for your purposes, while applying for others would be a very bad idea in certain circumstances.
It’s a good idea to go into a loan application armed with as much knowledge as you can possibly have. Here are some of the different kinds of loans you’ll encounter, as well as what they might mean for your finances in both the short-term and the long-term.
If you’re thinking of taking out a short-term loan, it pays to know some of the different kinds you can apply for. You might have heard a lot about payday loans, for example, which are effectively loans granted across a very short space of time with higher interest rates.
Short-term loans can be great if you really need some extra cash prior to a big paycheck, but they are definitely not a good way to maintain or improve your financial health in the long term, so you should only consider them if you know you’re going to be able to pay them back with interest.
Secured vs. unsecured loans
Broadly speaking, there are two main types of loan in the lending world: secured loans and unsecured loans. A secured loan is money borrowed against the value of something you own; usually, it’s a house, a vehicle, or some other high-value asset that you might forfeit if you can’t make repayments.
Conversely, an unsecured loan doesn’t have anything secured against it, which can often mean the amount you can borrow is lower but should also mean that you stand to lose less if you don’t make prompt repayments. Knowing this difference is very important.
Many lenders will offer loans specifically tailored towards consolidating any existing debt you might have. These loans generally have lower interest rates than the loans you might already be paying off, and their terms tend to be more favourable; after all, lenders know that you’re taking out the loan specifically because you’re struggling with debt, so they’re inclined to be more generous with their money.
That doesn’t mean you shouldn’t make regular repayments, though; not doing so can still have dire consequences, no matter who the lender might be.
Contrary to popular belief, credit cards are indeed a type of loan, and they’ll often be treated as such if you apply for one. This means you’ll be subject to many of the same checks you might undergo if you were applying for a standard loan, so you’ll need to make sure that your credit rating and financial history are robust.
Again, there are some credit card companies who will lend to you even if you don’t have a great credit history, but by and large, lenders will want to be reassured that you can pay money on your credit card back if you apply for one.
If you’re trying to get a business off the ground, you might be eligible for a small business loan. There are numerous different subtypes of these loans, too, so it’s not as simple as just applying for and receiving a business loan.
In broad strokes, though, business loans grant more money than personal loans do, but the lender is going to want to see much more of a guarantee that their money will be returned. If you’re seeking investment instead, it’s a similar situation; investors want to know you have a plan to give them a return on their initial investment.
Credit union loans
This type of loan is less common than the others, and is generally found in locations where people live or work together. In a credit union, members club together to combine their savings, thus allowing people to draw from a common pot of money for loans.
This is why credit unions tend to exist where there is a pre-existing bond; you wouldn’t want to trust strangers with a collaborative shared fund, after all. It’s worth looking up whether your place of employment or your residence has a credit union, because they can provide useful loans with favourable terms.
Rather than emphasising a traditional relationship between a lending company and a borrower, peer-to-peer lending unites those who have money to lend with those who want to borrow it. The relationship is usually more equitable, but this is still a classic loan with repayment terms and conditions, so you need to make sure you know what you’re getting into.
Don’t make the mistake of thinking peer-to-peer lending is more “friendly”; it’s simply eschewing the traditional corporate structure, and there are very few other differences between P2P lending and regular loans.
Technically, bank overdrafts could be said to count as a kind of loan. There are numerous differences, but in essence, your bank is allowing you to overspend in exchange for paying the money back at a later date.
Most banks will allow you to open an account with an overdraft already in place, so if you think you’re going to need one, it’s worth discussing this with your bank as soon as you can. Since banks are much bigger institutions than many lenders, you will often find they are amenable to renegotiation or discussion of your terms, even after the fact.