How Loans Work: Different Types of Financing
The way loans work can seem complicated and complex. Choosing the best loan for your situation begins by understanding the options available to you.
A loan’s terms, payment schedules, and interest rates may vary widely. Lenders may offer a particular loan product that other lenders may not, for example. And credit cards have their own unique features and benefits.
If you’re in the market for a loan, learning about the various types of financing available can make your lending decision easier. Here’s how different loans work.
Two main financing categories
Financing has two main categories: secured and unsecured.
Secured financing is asset-based, meaning that any amount of money you borrow must be backed, or “secured” by something you own. That asset is the collateral for your loan, which means if you default on the loan, the lender can claim the asset and sell it to recoup the loss. Secured loans often have a larger borrowing limit and you may be able to get a lower interest rate and a longer repayment period, compared with other types of financing.
Unsecured financing can be no-collateral installment loans, such as unsecured personal loans, or unsecured revolving lines of credit, such as credit cards. Even though unsecured financing isn’t backed by an asset, lenders still have recourse if you default, including sending your account to a collection agency. Because unsecured loans are riskier for lenders, banks and other lenders often require a higher credit score to qualify, and they also come with higher interest rates and less favorable terms than secured financing.
Revolving line of credit versus installment loans
Revolving credit and installment loans can affect your credit differently, and each have features that work better for certain financial situations.
Revolving credit is also referred to as open-end credit. With a revolving credit account, you can borrow money up to a set limit and then pay it back over time, with or without a determined end time. The biggest example of revolving credit is a credit card, but home equity lines of credit (HELOCs), and retail and department store cards fall in this category. Revolving credit usually has a variable interest rate that can change over time.
Although paying off the balance every month is not required on most revolving credit accounts, there will be a required minimum payment, usually monthly, and you’ll pay interest on the balance due. Your lender determines your credit limit and interest rate based on your credit score and history. As with other types of financing, missed payments can put your accounts in default and damage your credit score.
Installment loans, sometimes referred to closed-end credit, is financing with fixed interest rate and payments, and a specified date for repayment. Unlike a revolving line of credit, where you can choose to repay the balance as much or as little as you like as long as you make the minimum payment, an installment loan requires the same amount be repaid each month. You must follow a regular payment schedule until the entire loan balance has been paid.
A personal loan is the most common type of installment loan. Other examples include mortgages, auto loans, and alternative loans.
Read the fine print
Loan types vary widely because of their specific purpose. For example, mortgages are only allowed for buying or refinancing real estate. Each type of financing will have different timelines, terms, interest rates, payment dates, and other conditions. Be sure to read and understand the fine print before signing any agreement.
For example, loan terms vary, from short-term to long-term and everything in between. Time-based loans are for a specific period and are to be repaid within that time frame. Short-term loans include payday loans, which are typically meant to be paid back two to four weeks from the date. Terms for intermediate loans are usually one to three years, while long-term loans can last anywhere up to 25 years.
Another type of financing is a consolidation loan, which lets you combine your debts into a new loan with more favorable terms than you had before. Consolidation loans reduce the number of bills you pay each month and they typically have a fixed interest rate. Debt consolidation may not be a good idea if you continue charging up your credit cards.
The bottom line
When it comes to different types of financing, the options can be overwhelming. But knowing the differences can help you feel comfortable when choosing the right loan for your personal situation, even if you have bad credit or no credit.
If less-than-ideal credit is keeping you from getting what you need now, Snap Finance can help. We look beyond scores from major credit bureaus to give you the best chance of approval.¹ When you need financing, we can help you get what you need now and then make budget-friendly payments over time.
Snap-branded solutions include installment loans, retail installment contracts, and lease-to-own financing for all credit types.¹ Learn how Snap can help you shop now and pay later.
Snap-branded product offering includes retail installment contracts, bank installment loans, and lease-to-own financing. Talk with your local Snap sales representative for more details on which product qualifies at your store location. For more detailed information, please visit https://snapfinance.com/legal/financing-options
¹While no credit history is required, Snap obtains information from consumer reporting agencies in connection with submitted applications. Not all applicants are approved.