Types of Credits and Loans

Loans and credits can be extremely valuable when seeking to achieve certain objectives in life. Very often, people believe that taking loans from financial institutions is a “don’t” since it creates a debt for whosoever holds it. However, loans can be powerful financial tools for growth when taken to serve a specific purpose. In this article, we’ll be discussing the various types of credits and loans. You’ll learn about what kind of loan or credit matches your specific need while pinpointing a few risks involved in each type.

What are The Different Types of Loans?

Loans are essentially any financial product that provides money requested in a go. Based on the end-use of a loan, the most common types of loans include;

Personal Loans

This type of loan is often taken by people who do not have any preset specific purpose for the money. Events that can prompt the need for a personal loan include a marriage, home improvements, or emergency reasons.

Debt consolidations fall under this category. When you have high-interest debts such as credit cards, you can get a debt consolidation loan to clear it off. It is advisable to make use of this personal loan only if its interest rate is below the rate of the loans you would like to pay off. This may improve your credit score by reducing your credit utilization ratio.

Personal loans often do not require any collateral, which is why they are often termed as unsecured loans. A disadvantage with personal loans is the setting of a timeframe during which all money must be paid back.

Auto Loans

As the name implies, an auto loan is specifically given out to support the purchase of an automobile. This loan enables you to borrow the price of the car you want to get, excluding any down payments. Unlike a personal loan that needs no collateral, the vehicle purchased through an auto loan stands in as collateral for the debt. Should you fail to honor the terms of payment of such a loan, the vehicle will be repossessed by the lender.

Student Loans

Pursuing higher education may be quite costly especially when you’re going in for a prestigious school. Student loans come in to help in the financing of college or graduate school studies and are available via private and government lenders. Often, getting this loan through a federal institution has proven to be the better option. It may offer forbearance, income-based refund solutions, and deferment. However, this possibility to shift payment to a farther date is a major factor that increases the risk of being caught up with heavy interest to settle.

Mortgage Loans

A mortgage loan is quite similar to an auto loan. It covers the cost of purchasing a house while excluding all down payments and uses the property as collateral. If you get a mortgage loan but then fail to keep up with its payment terms, the lender may foreclose the collateral to recover the funds lent on it. This loan often has a long period for payment that may run up to 30 years at adjustable or fixed interest rates throughout the loan’s lifespan. Similarly to an auto loan, you may lose your home to the lender if payment is not made during the given period.

Note that loans may work based on different credit mechanisms which determine interest rates, payment cycles, and the ability to use a loan more than once.

Types of Credits

Credits mechanisms enable you to borrow money that can be paid back in different ways. The three types of credits are;

Installment Credit

Installment credits are loans where you borrow a sum of money and agree to repay it over a period, usually with interest. Once you’ve paid off the entire loan, the account is automatically closed. There are many types of installment credit loans, including auto loans, mortgages, personal loans, and student loans. Even if they may be very handy, their fixed payment schedule does not give you flexibility on when to make payments as such, any late payments may incur fees.

Revolving Credit

A revolving credit account allows you to borrow money from a single lender multiple times, up to a maximum limit. You can borrow as much as you want, and the lender will charge you interest on the amount you borrow each month. If you don’t pay the balance back by the due date, the lender can sell your debt to a debt collector. Credit cards and home equity lines of credit (HELOCs) fall under this credit type.

Though revolving credit is widely used due to its availability and lower interest rates, you must watch out for its dark side. Its terms of use can change at any moment and the account maintenance fees may be quite considerable since the credit has no collateral.

Open Credit

An open credit is like a revolving credit but for the fact that it must be paid at the end of each period. It is mainly made of utility bills such as mobile phone bills, electricity, and gas. You can use these various credits monthly and the service is renewed after payment for the current period has been made.

Implications of Different Types of Credits on Your Credit Score

Your credit score considers how well you manage your different types of debt. Essentially, having a variety of credit accounts can be helpful though it may not be easy to know exactly how many of each type are needed for a good score.

Your credit mix is one of the features that lenders use to calculate your credit score. Its value is important in showing how capable you are of handling different credit types responsibly. You can do so by combining two or three different account types like a credit card, a student loan, and a car loan. By making your payments on time and keeping your balances low, you can have good credit rapidly.

If you have good credit ratings, that’s good, but it won’t help you as much if you do not make on-time payments and keep a low credit utilization ratio. By respecting payment schedules, you can have a raise in your credit score.

The Bottom Line

Getting a loan can help you accomplish your goals sooner. Depending on the type of loan you need, it is important to identify the credit mechanism that applies to it. Open credits are almost inevitable nowadays with necessities like electricity that facilitate daily life. Revolving credits are ideal if you want to stay in control of how much funds you borrow and when to do so. Installment credits on the other hand can be good when you can hold up to certain levels of scheduled payments. Irrespective of the loan and credit types you go for, be sure not to get into debt for the sole sake of getting a loan or credit.