Borrowed money can be used for many purposes, from funding a new business to buying your fiancée an engagement ring. But with all of the different types of loans out there, which is best—and for which purpose? Below are the most common types of loans and how they work.
Most banks, online and on Main Street, offer personal loans, and the proceeds may be used for virtually anything from buying a new 4K 3D smart TV to paying bills. This is an expensive way to get money, because the loan is unsecured, which means that the borrower doesn’t put up collateral that can be seized in case of default, as with a car loan or home mortgage. Typically, a personal loan can be obtained for a few hundred to a few thousand dollars, with repayment periods of two to five years.
Borrowers need some form of income verification and proof of assets worth at least as much as the amount being borrowed. The application is typically only a page or two in length, and the approval or denial is generally issued within a few days.
Every time a consumer pays with a credit card, it is effectively equivalent to taking out a small personal loan. If the balance is paid in full immediately, no interest is charged. If some of the debt remains unpaid, interest is charged every month until it is paid off.
The average credit card interest rate carried a 16.88% APR at the end of the fourth quarter of 2019, according to a the Federal Reserve—down slightly from the 2019 second quarter rate of 17.14%, but almost exactly where it was (16.86%) at the end of the fourth quarter of 2018. Penalty rates, for consumers who miss a single payment, can get bumped even higher—for example, to 31.49% on at least two of HSBC's Mastercards.
People who own their own homes can borrow against the equity they have built up in them. That is, they can borrow up to the amount that they actually own. If half of the mortgage is paid off, they can borrow half of the value of the house, or if the house has increased in value by 50%, they can borrow that amount. In short, the difference between the home’s current fair market value and the amount still owed on the mortgage is the amount that can be borrowed.
Small business loans are available through most banks and through the Small Business Administration (SBA). These are typically sought by people setting up new businesses or expanding established ones.
Such loans are granted only after the business owner has submitted a formal business plan for review. The terms of the loan usually include a personal guarantee, meaning that the business owner’s personal assets serve as collateral against default on repayment. Such loans usually are extended for periods of five to 25 years. Interest rates are sometimes negotiable.
The small business loan has proved indispensable for many, if not most, fledgling businesses. However, creating a business plan and getting it approved can be arduous. The SBA has a wealth of resources both online and locally to help get businesses launched.
