Different Types Of Loans: What You Need To Know

Whether you’re an experienced financier or a complete neophyte, chances are you’ve been confused by the often difficult and labyrinthine world of borrowing and lending money. There are so many different kinds of loans out there that it can sometimes be difficult to know exactly where you should start or what kind of loan you need. Well, don’t worry – we’re here to help. Here’s our guide on the different kinds of loans, and what you need to know before you pursue them.

Secured Loans

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If you’re taking out a loan, the most common type you’re likely to come across is a secured loan. These loans are set up against something you own – property, valuable possessions, or other collateral. Secured loans tend to be higher in terms of the amount you’ll be allowed to borrow, and the interest rate is often lower too because the bank has secured the loan against whatever collateral it has.

There are several examples of secured loans you’re likely to come across. Mortgages are perhaps the most common. If you’re buying a house, chances are you’ll be doing so with a mortgage, which is essentially a loan secured against the value of your house. There are other kinds; logbook loans are popular with those who own cars and can secure loans against them. You may also encounter savings loans, pawnbroker loans, and more.

Unsecured Loans

As you may have guessed, unsecured loans are amounts of money lent to you without any kind of collateral or security to back them up. This means you’re borrowing money essentially on good faith; if you default on the loan, the lender won’t have anything concrete to hold against you. Of course, there are legal procedures in place if this happens, but unsecured loans tend to be lower as a result.

Many different banks and other financial institutions will offer unsecured loans, but whether you’re approved for one or not will depend largely on your credit score. Naturally, financial institutions will want to make sure you’re solvent and able to pay back what you’ve borrowed before they approve you for a loan. This sort of loan is best if you’re looking to start a home improvement project or pay for a new car or similar.

Peer-to-peer (P2P) loans

You can think of peer-to-peer lending as a form of loan which cuts out the middleman. P2P lending connects individuals who wish to borrow money with institutions and other individuals who are capable of lending it. There’s no go-between to dictate rates and add other stipulations, so contracts are usually drawn up solely between the lender and the person or organisation who’s doing the lending.

This type of loan has its benefits, of course, but also its drawbacks. Individuals can dictate repayment rates and aren’t bound to the kind of rules that cause defaults and unpaid debts, but due to a lack of regulation, P2P lending tends to have higher default rates anyway. It’s also worth bearing in mind that P2P isn’t covered by the UK FSCS (Financial Services Compensation Scheme), which protects savers up to £75,000.

Credit union loans

In order to be a part of a credit union, you’ll need to share something in common with the other members. This could be a shared place of employment, a common residential area, or similar. You won’t be able to join a credit union if you don’t have some kind of special status with other members, though, so don’t pursue this avenue if you’re a lone wolf or if your area doesn’t have a credit union.

The upside to credit unions is that they usually have lower interest rates and are able to help their members through financial difficulties. Credit unions rely on the accumulated savings of their members, and it’s these savings that constitute the pool of money lent to borrowers. These are co-operative organisations which often have better rates than banks but which also have restrictive entry requirements.

Payday (short-term) loans

If you’re hurting for cash right before payday, it can sometimes be a good idea to take out a payday (or short-term) loan. You’re unlikely to get the kind of money you’d be able to borrow from a bank with one of these loans, but you’ll get it quicker and the repayment period will be shorter too. It’s often possible to get short-term loans for amounts as low as £50, making them perfect for those in need of a quick injection.

It’s definitely worth reading up on payday loans before you go for this option. Not every payday lender is scrupulous; some will actively try to rip you off, while others will offer unfavourable rates based on arbitrary conditions. If you find the right payday lender, this can still be a viable option for you, especially in short-term times of financial trouble. Just be aware of a slightly higher risk of untrustworthy merchants.

Consolidation loans

If you see the phrase “consolidation loan” when you’re shopping for loans, be wary. These loans are often simply unsecured or secured loans marketed for the specific purpose of corralling lots of debt into one single repayment. As such, you may simply be applying for a loan without any special terms. This can still help you to make timely repayments, but it may not be what you think you’re signing up for.

A consolidation loan is essentially a way to marshal several different loans and create one single monthly repayment. This can be helpful if you’ve borrowed from several different places and need to keep better track of your financial outgoings. Before you apply for this type of loan, make sure your final monthly outgoing won’t be significantly higher than it was before you applied for the loan, as this will defeat the purpose.

About Mohit Tater

Mohit is the co-founder and editor of Entrepreneurship Life, a place where entrepreneurs, start-ups, and business owners can find wide ranging information, advice, resources, and tools for starting, running, and growing their businesses.

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