Different Types of Loans and How They Work

There are many different types of loans in the finance world. Each one comes with its own features, purpose, and pros and cons. If you need a loan, it's a good idea to learn more about different types of loans to help you pick the best loan to fit your needs.

In this article, we'll review types of loans and how they work, so you can get a better idea of the loan options out there.  

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Different Types of Loans

There are many different types of loans. There are prime and subprime loans, which is a loan category that has to do with interest rates and credit scores.

And there are loans meant to pay for a specific thing, like car loans to buy a car or mortgages to pay for a home.

But there are also loans that are just designed a certain way, but they aren't meant to pay for any one specific thing.  

Auto Loan: A type of loan provided by lenders to help car buyers finance the purchase of a car.

Student Loan: A type of loan provided by private or federal student loan providers to help students finance tuition for higher education.

Mortgage Loan: A type of loan provided by mortgage lenders to home buyers to help home buyers finance the purchase of a home.

Auto loans are handled by dealerships, credit unions, and banks to help customers pay for a car, student loans are handled by lenders and schools to cover students' tuition, and mortgage loans, or home loans, are handled by realtors and mortgage lenders to help prospective homeowners buy and set up payments for a house.  

These types of loans provide money that isn't usually given directly to the borrower. Instead, the lenders involved work directly with other organizations to pay for the car, home, or tuition and all borrowers have to do is make their payments.  

Personal Loan: A type of loan that can be used for various personal expenses and is usually based on creditworthiness and income.

Installment Loan: A type of loan that breaks payments into smaller chunks paid back in regular intervals known as installments.

Small Business Loan: A type of loan designed to provide funding for the financial needs of small businesses like operational expenses, expansions, or working capital.  

Home Equity Loan: A type of loan that uses a homeowner’s property as collateral so the homeowner can borrow against the equity in their home.

Title Loan: A type of loan that uses the borrower’s vehicle title as collateral so the car owner can borrow against the equity in their car.

Payday Loan: A type of loan with a short term and high interest rate that is generally due on the borrower’s next payday.  

Pawn Shop Loan: A type of loan provided by pawn shops where the borrower leaves something valuable as collateral at the pawn shop in exchange for cash.

Credit-Builder Loan: A type of loan designed to help individuals improve their credit score by borrowing small amounts and making on-time payments.

Debt Consolidation Loan: A type of loan designed to combine multiple debts into one loan to make debt repayment easier on the borrower.

Types of Short-Term Loans

Loan terms refers to the timeframe of the loan. Some loans are paid back over a longer period of time, like several years. While other loans are paid back over a shorter period of time, like a few months or even weeks.  

A long-term loan will have a loan term that is longer, like several years. This means the borrower will have several years to repay the loan.  

A short-term loan will have a loan term that is shorter, like a few months or weeks. This means the borrower will have a few weeks or a few months to repay the loan.

Types of short-term loans can include unsecured personal loans, installment loans, title loans, or payday loans. But ultimately, any loan that has a shorter term, or repayment period, might be considered a short-term loan.

Types of Mortgage Loans

There are several types of mortgage loans. A mortgage is a type of loan provided by mortgage lenders to home buyers to help home buyers finance the purchase of a home.  

But did you know there are also different types of home loans available to prospective home buyers?  

Conventional Loan: A type of mortgage loan that is provided by private lenders and is not guaranteed or insured by a government agency.

Jumbo Loan: A type of mortgage loan that is bigger than the maximum loan limits set by government-sponsored entities, like Fannie Mae or Freddie Mac.

Government-Insured Loan: A type of mortgage loan backed and guaranteed by a government agency, like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA).

Fixed-Rate Mortgage: A type of mortgage loan with an interest rate that stays the same throughout the loan term, providing monthly payment amounts that also stay the same.

Adjusted-Rate Mortgage: A type of mortgage loan with a fixed interest rate for a set period of time in the beginning, followed by periodic adjustments to the interest rate based on market rates.

There are also several types of commercial real estate loans. Commercial real estate is a type of property or real estate that is used to generate profit from capital gains or rental income.  

A commercial real estate loan is a type of business loan used to finance the purchase, renovation, or development of commercial properties. The following business loans can also be used as commercial real estate loans.

• Term Loan  
• Small Business Administration (SBA) Loan
• Business Line of Credit
• Bridge Loan

Types of Student Loans

There are many different types of student loans. A student loan is a type of loan provided by private or federal student loan providers to help students finance tuition for higher education.

There are private student loans and then there are 3 types of federal student loans as well. Federal student loans include direct subsidized loans, direct unsubsidized loans, direct plus loans.

Private Student Loan: A type of student loan provided by private lenders that covers expenses for higher education and is not backed by the federal government.

Direct Subsidized Loan: A type of student loan provided by the federal government where the US Department of Education pays the interest while the borrower is enrolled in school at least half-time, during deferment periods, and certain repayment periods.

Direct Unsubsidized Loan: A type of student loan provided by the federal government where the borrower pays the interest starting from the disbursement date.

Direct PLUS Loan: A type of student loan provided by the federal government for graduate or professional students and parents of dependent undergraduate students, where the borrower pays all accrued interest.

Types of Business Loans

There are many different types of business loans that companies both large and small might use from time to time. Many of these loans are designed specifically for business needs that wouldn't apply to an individual.  

Business Acquisition Loan: A type of business loan used to finance the purchase of an existing business or business assets.

Working Capital Loan: A type of business loan with a short term that provides businesses funds to cover day-to-day operational expenses and manage cash flow fluctuations.

Term Loan: A type of business loan with a fixed rate and a set repayment term used for long-term investments and business growth.

Small Business Administration (SBA) Loan: A type of business loan program backed by the government and designed to support small businesses with various funding needs.

Equipment Loan: A type of business loan designed specifically to help businesses purchase, finance, or lease equipment for business operations.

Commercial Real Estate Loan: A type of business loan used to finance the purchase, renovcation, or development of commercial properties.

Invoice Factoring Loan: A type of business loan where businesses sell their outstanding invoices to a financial institution at a discounted rate to access immediate cash flow.

Invoice Financing Loan: A type of business loan used to improve cash flow, with a short term, and secured by a company's outstanding invoices.

Export Financing Loan: A type of business loan that helps businesses engage in international trade by financing export-related activities.

Merchant Cash Advance Loan: A type of business loan provided to businesses in a lump sum in exchange for a percentage of future credit card sales.

Bridge Loan: A type of business loan with a short term that "bridges" the gap between businesses financing needs and cover immediate expenses until permanent financing is secured.

Microloan: A type of business loan with a small loan amount offered by non-profit organizations or government agencies to support startups and small businesses.

Business Line of Credit: A type of revolving credit line that provides businesses with access to a predetermined limit that businesses can borrow from for various business expenses.