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Personal Loans

Credit Cards

Home-Equity Loans

Home Equity Lines of Credit

Cash Advances with Credit Card

Small Business Loans

Personal Finance Loans

Understanding Different Loan Types

Pick the option that best suits your financial situation

By Glenn Curtis

Updated June 19, 2021

Reviewed by Thomas Brock

The money you borrow is a great option for a variety of reasons, from financing an entrepreneur’s new venture to buying your fiancee an engagement ring. But with all of the various types of loans out there, which is best–and to what reason? Here are the most popular kinds of loans and how they work.

The most important takeaways

The personal loans or credit cards come with high interest rates but don’t require collateral.

Home-equity loans offer low rates of interest However, the home of the borrower serves as collateral.

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

Personal Loans

Most banks, online or on Main Street, offer personal loans which may be used for virtually everything from purchasing a brand new 3D 4K smart TV to paying for bills. This is an expensive way to obtain money because the loan is not secured, which means the borrower does not put up collateral that can be taken away in the event in the event of default, similar to the case of a car loan or mortgage on a home. Typically, a personal loan is available from a few hundred dollars to several thousand dollars with repayment times of 2 to five years.

Borrowers need some form of income verification and evidence of assets that are at least as large as the amount being borrowed. The application is typically only a page or two in length. The approval or denial is generally given within a couple of days.

Best and Worst Rates

The average interest rate for a 24-month commercial bank loan was 10.21% for the quarter ending in April of this year, according to the Federal Reserve.1 However, interest rates could be more than three times that amount: Avant’s APRs range from 9.95% to 35.99%.2 The best rates can only be obtained by people with exceptional credit ratings and significant assets. The most adversities must be endured by those who have no alternative.

Personal loan is most likely the best option for those who must get a modest amount of money and are certain they can repay it within a couple of years. A personal loan calculator can be an effective tool to determine the interest rate that is within your reach.

Bank Loan vs. Bank Guarantee

An institution’s loan does not mean the same as a bank’s guarantee. A bank may issue a guarantee as surety to a third party on behalf of one of its customers. If the customer fails to fulfill the relevant contractual obligation to the third party, that third party may demand an amount from the bank.

The guarantee is typically an arrangement that banks make for their small-business customers. A corporation may accept the bid of a contractor for instance, but on the condition that the bank of the contractor issues a guarantee of payment in the event that the contractor defaults in the terms of their contract.

A personal loan might be best for those who need to borrow a small amount and is certain of their capability to pay back the loan within a couple of years.

Credit Cards

Each time a customer uses a credit card to pay it’s equivalent to taking out a personal loan. If the balance is paid in full within a few hours and no interest is paid. If a portion of the debt is not paid, interest is charged every month until it is paid off.

The average credit card interest rate carried a 16.88 percent APR at the close on the final quarter in 2019, according to a Federal Reserve. It was down slightly from the 2019 second quarter rate of 17.14%, but nearly exactly where it was (16.86%) at the close of fourth-quarter 2018.3 Penalty rates, for consumers who miss a single payment, can be increased further, for instance up to 31.49 percent for at least two HSBC Mastercards.4

Revolving Debt

The big difference between a creditcard as opposed to a private loan can be seen in the fact that the credit card is a revolving debt. The card has a set credit limit, and its owner can borrow it repeatedly until the limit is reached and pay it back over the course of time.

Credit cards are extremely useful, but they do require discipline to stay away from overindulgence. Studies have shown that consumers are more inclined to spend when they use credit cards instead of cash. The simple application form of one page is a more efficient method to obtain the $5,000 or $10,000 worth of credit.

Home Equity Credit

Homeowners who own their own residences can borrow against the equity they have accrued in them. That is, they can borrow up to the amount they have. If the mortgage is half is paid off, they may borrow half of the value of the home, or if the house has appreciated by 50%, they can borrow that amount. In essence, the difference between the home’s current fair market value and the remaining amount owed to the lender is what is able to be borrowed.

Low Rates, Bigger Risks

One benefit of a home equity loan can be that the interest rate is much lower than that of personal loan. According to a survey conducted by ValuePenguin.com The average interest rate for a 15-year fixed rate mortgage loan as of Feb. 5, 2020, was 5.82 percent. Due to changes made in the tax law of 2017, the Tax Cuts and Jobs Act, interest on a home equity loan is no longer tax-deductible when the money can be used “buy, build, or significantly improve the taxpayer’s home that secures the loan” as per the IRS.5

The biggest potential downside is that the house is the collateral for the loan. The borrower can lose their home in the event of failure to pay the loan. The money from a home equity loan can be used for any reason however, they are typically utilized to improve or extend the property.

A consumer considering a home-equity loan may be able to recall two lessons that the financial crisis of 2008-2009:

Home values could go down as well as up.

Jobs are in jeopardy in an economic recession.

Home-Equity Lines of Credit (HELOCs)

The home-equity line of credit (HELOC) functions like credit cards but utilizes homes as collateral. An amount up to a certain amount is granted to the borrower. A HELOC may be used, repaid, and reused for as long as the account remains in good standing, which usually is 10 to 20 years.

Similar to a traditional home equity loan however, the interest could be tax deductible. However, unlike a traditional home equity loan, the interest rate cannot be determined at the time the loan is approved. Since the borrower could be using the funds anytime over a long period The interest rate is typically variable. It can be linked to an index of the underlying, like the prime rate.

Good or Bad News

Variable interest rates could be good as well as bad. During a period of rising rates, the cost of interest on a balance that is not paid will rise. Someone who takes out a loan to construct a new kitchen and then pays it back over the course of a few years, for instance, may be forced to pay more interest than anticipated, just because the prime rate increased.

There’s a second risk. The credit lines that are available can be huge and the initial rates very attractive. It is easy for people to get in way over their head.

Credit Card Cash Advances

Credit cards usually include an option to cash advance. Anyone with an account with a credit card can access an unrevolving line of cash accessible at any automatic ATM (ATM).

This is an extremely expensive way to borrow money. To take one example the interest rate for cash advances with Fortiva credit card is Fortiva credit card ranges from 25.74% up to 36 percent, contingent on your credit.6 Cash advances are also accompanied with a cost, usually equivalent to 3 to 5 percent of the loan amount or a $10 minimum. Worse yet, the advance will be added to the balance of your credit card, accruing interest from month to month until it’s paid off.

Other Sources

Cash advances are occasionally available from different sources. Notably, tax-preparation companies may offer advances against an expected Internal Revenue Service (IRS) tax refund. But, unless you’re in a critical emergency, there’s not a reason to sacrifice a portion or all of the tax rebate just to get the money quicker.

Small Business Loans

Small business loans are available through the majority of banks and through the Small Business Administration (SBA). They are usually sought out by people setting up new businesses or expanding established ones.

These loans are only granted once the owner of the business has provided a formal business plan for review. The conditions of the loan typically contain a personal guarantee, meaning that the business owner’s personal assets serve as collateral in case of default upon repayment. These loans generally extend for 5 to 25 years. Interest rates are sometimes negotiable.

The small-business loan has proved indispensable for several, if certainly not all small businesses that are just beginning to emerge. But, preparing the business plan and then getting it approved can be arduous. The SBA offers a variety of information both on the internet and in person to help companies get their businesses up and running.