Which Type of Loan to Choose? The Different Loan Types and Words to Know

Loans are a complicated financial instrument, and they come in many different variants. Knowing the relevant financial terms and which type of loan fits your financial situation can help you pick the best option.

Choosing the Type of Loan: Revolving or Closed
You can divide loans into two broad categories. Revolving or open-end credit refers to loans that you can access continuously. This includes credit cards and lines of credit.
Closed-end credit is credit that you use to finance a specific purchase, like a car or student loan, or a mortgage. You have to pay them back on a regular schedule over a set period until you've paid down the balance.

By looking at what you want to do with your loan, you can choose which type of credit to talk to a financial institution about.

Secured and Non-Secured Loans
Beyond the payment schedule, your credit score will also determine if you can access non-secured loans. A secured loan is a loan that has an asset, usually a house or car, leveraged against borrowing. This means that if you default on the loan, the lender can seize that asset to pay back what you owe.

A non-secured loan is a loan given to you based on your credit history. Credit cards are the most common type of non-secured loan: the average American has 2.6 credit cards. However, it can be hard to gain access to non-secured loans like credit cards if you do not have a good credit score.

Bad credit installment loans are a way to gain access to loans if you have a bad credit score. You pay them back at set intervals over time, much like a mortgage. Each payment is the same, which helps prevent unpredictable charges.

Paying back installment loans is a good way to build your credit score as well. In fact, if you have extra money, you can get an installment loan for the sole purpose of building your credit score.

Fixed and Variable Rate Loans
Another difference that exists between different loans is the interest rate charged. Fixed rate loans guarantee a specific interest rate: things like credit cards and installment loans are fixed-rate loans. This provides stability and predictability to your payments.

However, fixed rate loans generally stay a little higher than the market rate so that lenders can make money. You may be able to get a lower rate if you go with a variable rate loan. These loans can have their rates change if the market shift, and can either shrink or grow much larger.

Of course, variable rate loans carry a degree of risk, but they are a good choice if the market is currently favorable, or for smaller loans.

Continue to Improve Your Financial Literacy
Now that you know the many different type of loans, you can be smarter in your search for credit. Feel free to search through our site for more information on financial terms to aid you in your personal finance journey.