Most people need to borrow money at some point. Americans owe more than $13 trillion in total debt. Borrowing is clearly an expensive proposition for many American families.
If you do find yourself borrowing to buy a home, a car, an education, or anything else, it is important to look at the pros and cons. It’s all about making the right long-term decisions and minimizing out-of-pocket costs. Let’s look at what you need to know to best evaluate loan options available to Americans today.
Common Types of Loans
Loans come in many names and forms. When looking at consumer loans (loans to people and not businesses) there are four main categories: mortgages, student loans, personal loans and auto loans.
While these are the most common ways to borrow, there are some substitutes for traditional loans to use instead. Those include credit cards, lines of credit, home equity lines of credit and borrowing from yourself with a 401(k) loan.
Not all loans are created equal. It is important to understand some of the similarities and differences between the various types of loans and alternatives.
What All Loans Have in Common
All loans and borrowing products have a few features in common. Here are a few of the most important places to look:
The first place to look with any loan is the interest rate. This is the main way you pay for borrowed funds. Depending on the type of borrowing, rates can be single-digit percentages or hundreds of percentage points for the worst short-term loans.
Common fees with loans include origination fees, late and returned payment fees, annual fees and early payoff fees. Fewer and lower fees are better.
Every loan requires you to pay it back somehow. Depending on the type and duration of the loan, your minimum payment will vary.
The vast majority of loans require monthly payments, but some allow you to pay more frequently or require a different schedule.
Is the company you plan to borrow from an upstanding, trustworthy company? Only work with licensed, reputable lenders.
Features of Popular Loans
Here is a brief summary of each of the major types of borrowing, including traditional loans and other lending products.
Mortgage loans are a type of loan where you borrow to buy a property, most often a single family home or condo. The most popular type of mortgage is a 30-year fixed loan, where you pay the same payment and interest rate for the next 30 years or until the loan is paid off.
Student loans are one of the fastest growing categories of borrowing. From banks and nonbank lenders, student loans help pay for the cost of a college or university education. Some loans are backed by the U.S. government, which means lower rates and better terms than private student loans.
A personal loan is an unsecured loan. The best personal loans these days often come from credit unions and online lenders. Payday loans fall into this category. You should avoid this type of predatory loan if at all possible. Payday loans typically charge high interest rates.
Car loans are similar to a mortgage, except secured by the car instead of a home. When a loan is secured, it means the bank can take (foreclose) the asset if you stop paying. Most car loans are around two to seven years long with a fixed monthly payment
Credit cards are a form of unsecured loan, and they often charge interest rates from around 7 percent for the best cards and borrowers up to 30 percent for the worst cards. Beware credit card debt. It is a lot easier to spend than it is to pay it back.
Lines of Credit
A line of credit can come in several forms. One popular form is as a personal loan, or an unsecured loan. Lines of credit are revolving accounts, which means you can add to the balance and pay it off again and again over the life of the account.
Home Equity Lines of Credit
A Home Equity Line of Credit, or HELOC, is a secured line of credit. It is a hybrid of a personal line of credit and a mortgage. Because a HELOC is secured by your home, it gets a better interest rate than nearly anything else other than a mortgage. But you can spend on it like a credit card.
A 401(k) loan should be a very last resort. Taking from your 401(k) means borrowing from your retirement, and if you don’t pay it back you get hit with a handful of fees and penalties. Avoid this type of loan if at all possible.
This is not an exhaustive list of every type of loan. Many others exist that fall within these categories, and there are some less common and customized loans available in real estate, business, construction, and other areas.
Go Into Lending With Your Eyes Wide Open
Some finance experts suggest there are good debts and bad debts. Good debts arguably include a mortgage, which get you a home, and student loans, which get you an education. However, not all student loans or mortgages are good or affordable.
When it comes to cars, credit cards, and anything else, it’s best to avoid borrowing if you can’t afford to easily pay it off in full from savings. If you pay off your credit cards in full before the due date, you never have to pay interest. This is where valuable rewards cards come in. Savvy spenders buy with cards and pay them off to get rewards but avoid the costs.
Even with “good debt,” borrowing has costs. Avoid borrowing when you can. But if you do need to take out a loan, make sure you get the right loan with the most favorable terms for your needs.