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Personal Loans

Credit Cards

Home-Equity Credit

Home Equity Lines of Credit

Cash Advances with Credit Card

Small Business Loans

Personal Finance Lending

Understanding Different Loan Types

Pick the option that best suits your financial situation

By Glenn Curtis

Updated June 19 2021

Reviewed by Thomas Brock

Money borrowed is a great option for a variety of reasons, from financing an entrepreneur’s new venture to buying your partner an engagement wedding ring. With all the different kinds of loans out there, which is best–and for what reason? Here are the most commonly used types of loans and how they work.

Important Takeaways

The personal loans or credit cards are characterized by higher interest rates, but don’t require collateral.

Home-equity loans have low interest rates however the home of the borrower serves as collateral.

Cash advances usually have high rates of interest and transaction charges.

Personal Credit

Many banks, both online and located on Main Street, offer personal loans and the money can be used for anything from buying a new 3D 4K smart TV to paying bills. This is a costly way to borrow money, as the loan is not secured, which means the borrower isn’t required to provide collateral that could be taken in the event in the event of default, similar to a car loan or mortgage on a home. Typically, a personal loan is available from a few hundred dollars to a few thousand dollars, with repayment terms of two or five years.

For borrowing, you must have income verification and evidence of assets that are that are at least as large than the amount they are borrowing. The application typically is just a couple of pages in length, and the decision to approve or deny the application is usually given within a couple of days.

Best and Worst Rates

The average interest rate for a commercial bank’s 24-month loan was 10.21% during the 4th quarter of 2019 according to the Federal Reserve.1 However, interest rates could be more than three times the amount. For example, Avant’s APRs vary from 9.95% to 35.99%.2 The most favorable rates can only be accessed by people with exceptional credit ratings and substantial assets. The most adversities must be endured by those who have no other choice.

A personal loan is probably the best way to go for those who have to take out a small amount of money and are certain that they will repay the loan within a couple of years. The personal loan calculator can be an effective tool to determine what kind of interest rate is within your reach.

Bank Loan vs. Bank Guarantee

A bank loan does not mean the same as a bank’s guarantee. A bank could offer a guarantee in the form of a surety to a third party for one of their customers. If the customer is unable to perform the required contractual obligation with this third-party, that party can require payment from the bank.

The guarantee is usually an arrangement that banks make for their small-business customers. A business may be able to accept a contractor’s bid for instance, but on the requirement that the contractor’s bank issues a guarantee of payment in the case of default with the agreement.

A personal loan might be best for someone who needs to borrow a small amount of money , and is certain of their capability to repay it in a few years.

Credit Cards

Each time a customer uses a credit card to pay it’s essentially equivalent to taking out a small personal loan. If the balance is paid off in full in the first day there is no interest charged. If some of the debt is not paid the interest will be charged each month until it is completely paid off.

The typical credit card interest rate was 16.88 percent APR as of the end in the 4th quarter 2019 as per Federal Reserve. It was down slightly from the 2019 second quarter rate of 17.14%, but nearly exactly the same as it was (16.86 percent) at the close of the fourth quarter of 2018.3 Penalty rates, for those who fail to make one payment, could be raised even more–for instance the rate is 31.49% on at least two of HSBC’s Mastercards.4

Revolving Debt

The big difference between a credit card and a personal loan can be seen in the fact that the card represents revolving debt. The card has a set credit limit and the owner can repeatedly borrow money until the limit is reached and pay it back over the course of time.

Credit cards are very useful, but they do require discipline to stay away from overindulgence. Research has shown that people are more likely to spend money when they use money instead of plastic. The simple application form of one page is a more convenient way to get an amount of $5,000 or $10,000 in credit.

Home-Equity Credit

Homeowners who own their own homes can borrow against the equity accrued in their homes. This means that they can borrow up to the amount that they actually have. If the mortgage has been paid in half is completed, they are able to borrow the entire value of the home or, if the home has appreciated by 50%, they can borrow that amount. In short, the difference between the property’s fair market value and the remaining amount due for the loan is how much is able to be borrowed.

Lower Rates, Higher Risks

The benefit of a home equity loan is that the interest rate is far lower than for a personal loan. According to a survey conducted by ValuePenguin.com The median interest rate for a 15-year fixed-rate home equity loan in the month of Feb. 5th, 2020 was 5.82 percent. As a result of changes in the 2017 Tax Cuts and Jobs Act the interest rate on the home equity loan is now only tax deductible if the money can be used «buy, build, or significantly improve the home of the taxpayer that is secured by the loan» according to the IRS.5

The most significant risk is the fact that the house serves as the collateral for the loan. The borrower could lose their home in the event of failure to pay the loan. The proceeds of the home equity loan can be used for any use, but they are often utilized to improve or extend the property.

Anyone who is considering a home equity loan might keep in mind two lessons that the financial crisis of 2008-2009:

Home values could go down and up.

Jobs are in jeopardy in an economic downturn.

Home-Equity Lines of Credit (HELOCs)

The home-equity line of credit (HELOC) is similar to credit cards but utilizes homes as collateral. The maximum credit amount can be extended to the borrower. A HELOC may be used to repay, or used again for as long as the account remains open, which typically 10 to 20 years.

Like a regular home-equity loan, the interest may be tax-deductible. However, unlike a normal home equity loan however, the interest rate cannot be set at the time the loan is granted. Because the borrower is using the funds anytime over the course of a few years and the rate of interest will be variable. It could be tied to an index of the underlying, for instance, the prime rate.

Good or Bad News

Variable interest rates can be either good or bad news. During a period of rising rates, the cost of interest on an outstanding balance will rise. If a homeowner takes out loans to construct a new kitchen, and then repays it over the course of a few years for instance, might be forced to pay more in interest than they anticipated due to the fact that the prime rate increased.

Another issue could be the cost. The credit lines are often very extensive and the introductory rates are very appealing. It is easy for people to get in the middle of their finances.

Cash Advances on Credit Cards

Credit cards usually include an option to cash advance. Effectively, anyone who has an account with a credit card can access an revolving cash line accessible at any automatic ATM (ATM).

It is a very expensive way to borrow money. For instance, the interest rate for cash advances with Fortiva credit card is Fortiva credit card is 25.74% up to 36 percent, based on the credit score of your credit.6 Cash advances come with a fee, typically equivalent to 3 to 5 percent of the amount you are requesting or a $10 minimum. Worse yet, the advance will be added to the balance on the credit card, accruing interest from month to month until it’s completely paid off.

Other Sources

Cash advances can be obtained from different sources. Tax preparation firms may offer advances against an expected Internal Revenue Service (IRS) tax refund. If there’s no dire emergency, there’s no reason to give up part of your tax refund to make the money go a little faster.

Small Business Loans

Small business loans are offered through a variety of banks as well as through the Small Business Administration (SBA). They are usually sought out by people setting up new companies or expanding existing ones.

The loans are only granted when the owner of the company has submitted an official business plan for review. The terms of the loan usually include personal guarantees, which means that the owner’s personal assets serve as collateral against default in repayment. The loans generally extend for 5 to 25 years. Rates of interest are often negotiated.

The small-business loan has proved indispensable for many, if not most, fledgling businesses. But, preparing the business plan and then getting it approved can be arduous. The SBA has a wealth of information both online and locally to help start businesses.

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