Whether you're planning on buying a home, getting a new car or furthering your education, you may have some questions about what type of loans you'll need to pay for it. It can be intimidating trying to find the right financing in a sea of various lending options. We've narrowed down the most common types of loans that cover a broad spectrum of financing options you may encounter while trying to reach one of many life goals.
Different Types Of Loan Categories
First, let's take a look at the different categories common loans fall into. When you get a loan, it will be either secured or unsecured, open-ended or closed-ended and, if you're getting a mortgage, nonconforming or conforming.
Secured And Unsecured Loans
Secured loans require you to offer up a personal asset, such as a home or a vehicle, to obtain the loan. If you default on your payment, the lender ount and interest rates depend on the value of the offered asset, along with your credit score and income. Interest rates are generally lower because the collateral offers a lower risk to the lender. The most common types of secured loans are auto loans and mortgages. You'll typically borrow the appraised value of the home or car minus any down payment you make on it. If you default on your loan, the car or home can be taken away.
Unsecured loans are personal loans not backed by any collateral. However, that doesn't mean nothing happens if you default on the loan. If you stop making payments on an unsecured loan, the lender can charge you fees, hand you over to collections or take you to court.
Since you aren't offering any collateral, the interest rate and loan amount for unsecured loans are determined by your credit score and income. It's important to remember that unsecured loans typically have a higher interest rate than secured loans because there's more risk involved. One example of this type of loan is a credit card. Credit cards have an average interest rate of about 20%, compared to the average auto loan interest rate of about 5% – depending on your credit.
While the act of collecting on defaulted loans differs by whether it's secured or unsecured, there is one major consequence that happens if you default on either type of loan: harm to your credit. Not only will defaulting on a secured or unsecured loan negatively impact your credit score; it will also stay on your credit report for up to 7 years. This can make it difficult to open new lines of credit or purchase a home in the future.
Open-Ended And Closed-Ended Loans
Open-ended loans feature a fixed-limit line of credit that can be borrowed from again and again. Your available credit decreases as you spend and increase with every repayment you make. Two common examples of open-ended loans are credit cards and home equity lines of credit (HELOCs).
Closed-ended loans are one-time loans that cannot be borrowed from again. The loan amount is fixed and repaid over an agreed-upon amount of time. As you pay down the loan, you cannot take more money out. If you need to borrow more money, you must repeat the application and approval process for the loan. A few examples of closed-ended loans include mortgages, student loans and auto loans.
Nonconventional And Conventional Loans
Nonconventional and conventional loans are two different mortgage loans. The category the loan falls into has to do with how it's insured and what guidelines the lender follows.
Nonconventional loans , or government loans, are backed by the government. That means the government insures these loans, which typically have more lenient qualifications, like lower credit score and smaller down payment requirements. This can make them a more obtainable financing option for someone who ples of nonconventional loans are the FHA loan, USDA loan and VA loan.
Conventional loans are backed by private lenders, such as a bank, a credit union or a mortgage lender, and not by any government entity. These loans have stricter qualification requirements because, without government insurance, the lender is the one at risk of losing money if the borrower defaults. These loans usually require a stronger credit score and a larger down payment.
Conforming And Nonconforming Loans
Conforming loans follow (or conform to) guidelines set by Fannie Mae and Freddie Mac, government-sponsored enterprises that buy mortgage loans. The Federal Housing Finance Agency (FHFA) oversees Freddie Mac and Fannie Mae and sets funding criteria, including a maximum loan amount these entities can purchase. The loan limit for 2021 is $548,250 for most ount someone intends to borrow, loan qualifications for conforming loans depend upon the borrower's debt-to-income ratio, as well as loan-to-value, and their credit history.
Nonconforming loans do not follow guidelines for Fannie or Freddie, and thus do not qualify under those entities. These are loans that are above the loan limits set by the FHFA and are often referred to as “jumbo” loans. If you require a loan amount that exceeds the conforming loan limit, you'll need to get a nonconforming loan. Since these loans are riskier for lenders, they may be harder to obtain.