Understanding Types of Loans and Line of Credit Options
Reading time: 4 Minutes
June 18th, 2021
Before borrowing money, you want to make sure you understand some debt and borrowing fundamentals. For debt basics, including the difference between good debt and bad debt, be sure to read Debt: The Good, The Bad, and How to Manage Each. For strategies on how to get out of debt, read Get out of Debt: Tips for Taking Control of Your Finances. For all the basics around loans (what is a loan, key terms to understand, how to get a loan, how do loans work, etc) read Tips for Borrowing Money: What You Need to Know about Loans.
Finally, you want to make sure you understand what types of loans are available.
With so many different kinds of loans, this article will walk you through some of the most common types. You'll also learn the difference between a loan and a line of credit and how your credit score comes into play when you want to take out a loan.
Types of Loans
Before explaining the types of loans available, it's important to know that all loans fall into two categories: secured loans and unsecured loans.
Secured loans are backed by collateral to guarantee repayment of the loan. Should you fail to make your payments, the lender can reclaim the collateral to satisfy the debt. Because you assume more risk with a secured loan, the amount available to borrow is typically higher, easier to get, has a lower interest rate, and a longer length of time to repay than an unsecured loan.
Unsecured loans do not require the borrow to offer up a valuable asset. Because of this, they might have a higher interest rate than a secured loan, and the amount you can borrow is typically lower.
Here are the most common types of loans you'll encounter when you need to borrow money:
- Mortgage Loans. Mortgages are long-term, secured loans used to finance residential properties, including houses, condominiums, duplexes, and multi-family properties. Interest rates on mortgages can be fixed or adjustable. You can learn more about buying a home in Hawaii here.
- Home Equity Loans. A home equity loan is a loan secured by the equity in your home. Borrowers often use these to pay for large projects like renovations or paying off credit card debt at a higher interest rate.
- Auto Loans. Also a type of long-term secured loan, auto loans are used to buy cars. Monthly payments make a larger purchase like a car more affordable.
- Student Loans. Used to fund education-related expenses like tuition, room and board, and textbooks, student loans are unsecured, long-term loans, and funded through private lenders or the federal government.
- Personal Loans. Personal loans can be either secured or unsecured and can be used for a wide variety of purposes. Some common uses are for consolidating debt and home renovations.
- Title Loans. Title loans are usually short-term loans secured by the title to your car, which you surrender to obtain the loan. They can be attractive to borrowers with lower credit scores who own their car outright as they don't require a credit check to qualify.
- Pawn Shop Loans. A pawn shop loan is a short-term loan secured by the collateral you "pawn." A pawn shop will determine the item's value and then offer you a loan based on its worth. The shop will keep your item until you pay off the loan.
- Credit Card Cash Advances. A cash advance on your credit card is a type of short-term loan. Interest rates and fees on these loans are quite high as they are unsecured loans and easy to obtain if you have available credit. Funds can be withdrawn through an ATM or by using special checks your credit card company issues.
Loans vs. Line of Credit
While loans and lines of credit are both ways for you to borrow money, being able to compare loans vs. lines of credit will help you know when each might be useful.
A loan is a non-revolving debt, which means that you'll have to re-apply for a new loan when you pay off the loan if you want to borrow more money. Your credit score and credit history will impact your loan terms like interest rate and repayment term. Loans are also issued for a specific dollar amount.
A line of credit is a revolving debt, which means once you pay off the amount your draw from your line, those funds are available to use again. Lines of credit operate like credit cards in that you're given a credit limit based on your creditworthiness, and you can draw on your available credit regularly or have the line available in case of emergencies. Unlike a credit card, however, a line of credit is a secured loan. Credit lines, also, typically have lower total dollar amounts than loans and higher interest rates, and unlike a loan, you'll only incur interest when you use funds from the line of credit.
Borrowing Money and Your Credit Score
Now that you know about the different types of loans available and the difference between a loan vs. line of credit, you need to know how your credit score impacts your loan or credit line terms.
When you apply for credit, a lender will pull your credit report and score to determine how risky it is to lend you money. The lower your credit score, the higher your interest rate may be to borrow money, increasing the total amount you pay for whatever you buy in the long term. The higher your score, typically the lower your interest rate, which decreases the total cost you pay for what you buy.
It takes time to build a solid credit history, and a low score could mean you're a newer borrower. However, a low credit score could also mean you have too much debt to be seen as a good lending risk. Whatever your credit score situation, you can increase your score by following a few tips and decrease your borrowing cost in the process.
Your Next Borrowing Steps
Over your lifetime, you'll likely encounter the need to borrow money and this can be a complicated process. Be sure to understand what options you have available and the terms and conditions of each. For more information, visit Bank of Hawaii's personal loans and lines of credit or one of our branches to learn more.
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