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Consumer Loan: What You Need to Know

October 23, 2020 by Daniel Azzoli

People shaking hands over a consumer loan.

As you move through life, you may find that the ability to borrow money can help in different sorts of ways. Whether you’re buying a house, renovating your home, or you need help with an emergency expense, a consumer loan may be able to help. But how do you define this important financial term exactly?

Well, put simply, a consumer loan is an umbrella term that refers to different types of personal loans which you can apply for to help you finance a number of different things. It’s basically any personal loan that is lent out by a financial institution.

But with a definition as broad as the one we’ve just given, it’s important to zoom in a little and understand some of the important details surrounding these types of loans. So, in this article we’re going to go over the differences between secured and unsecured consumer loans, open-end and closed-end loans, and then dive into some of the most common types of consumer loans.

Differences Between a Secured and Unsecured Consumer Loan

Within the world of consumer loans, one of the big distinctions between them is whether they’re secured or unsecured. With a secured loan, you’ll need to provide collateral in order to be qualified. Collateral is a personal asset that you agree to give the financial institution in the case that you’re not able to meet your loan payments. Because these loans are secured by collateral and the risk for the lender is mitigated, they may come with higher loan amounts and lower rates than an unsecured loan.

On the other hand, to be qualified for an unsecured loan, you won’t need to put up any sort of asset. Instead, your eligibility may be determined by your credit score, your income, and a number of other factors. The eligibility requirements for loan approval can vary between different lenders.

Because you’re not providing a lender with collateral, they’re taking on more risk by lending to you. This may result in unsecured consumer loans having higher rates, lower loan amounts, and shorter repayment terms. However, you won’t have to risk losing an important asset in order to be approved.

Open-end vs. Closed-end Consumer Loan

Another important distinction between different types of consumer loans is whether they’re open or closed-ended. With an open-end loan, you’re given a maximum loan limit which you’ll be able to draw funds from on a continuous basis, as long as you’re paying down your balance and your account is in good standing. These types of loans are considered to be revolving credit.

Person signing a consumer loan.

One of the most common examples of an open-end consumer loan, (which we’ll go over in more detail later) is a credit card. With a credit card, you (the consumer) will be able to borrow money up to your credit limit, and will then need to pay back the amount you’ve borrowed before the due date. If you don’t, you’ll be charged interest (and potentially certain fees) until you’re able to pay back what you’ve borrowed.

A closed-end consumer loan works a little differently. Instead of being given a credit limit which you can draw from as much or as little as you’d like, you’ll be given a lump sum if you’re approved. You’ll need to pay this money back, along with interest and/or fees, over a period time which can vary depending on the type of loan, the frequency in which you get paid, and other factors.

One common example of this would be consumer installment loans. With an installment loan, you’re given a lump sum which you’ll need to pay back over the course of pre-determined, scheduled payments. The terms of these loans can vary based on a number of factors.

Different Types of Consumer Loans

Now that we’ve looked at some of the important categories that a consumer loan can fall into, it’s time to define the types of loans themselves. Keep in mind that we haven’t listed every single type of loan here, but these are some of the more common ones. Let’s get started.  

Payday Loans

A payday loan is a small-dollar, short-term personal consumer loan with a quick turnaround time in terms of repayment. With these loans, you’ll be given a lump sum if approved, and you’ll need to pay it back along with any interest and/or fees by your next pay date.

It’s important that you do your research on payday loans online. These loans typically come with high interest rates and need to be paid back relatively quickly, so you’ll need to consider the risk before applying. You should also only ever apply for one if you need help dealing with an emergency expense that needs to be dealt with right away, and you have no other way of dealing with it. These loans aren’t meant to help you take care of any sort of long-term financial issues, so make sure you exhaust your other options and only apply for one as a last resort.

Consumer Installment Loans

These personal installment loans are similar to payday loans in that they’re a closed-end loan in which you’ll be given a lump sum, but the main difference between the two is in the repayment period. Like we mentioned in the previous section, with a payday loan, you’ll typically need to pay it back by your next pay date. But with an installment loan, your payments are spread out over the course of several pre-determined payments that typically span several months. When payments are spread over the course of months as opposed to weeks, it may make it easier for you to meet all your payments in a timely manner.

While this payment format may make things a little easier on you, these consumer loans can often still be expensive. They should generally only be used when you find yourself in an emergency situation without the savings to handle these expenses.

Line of Credit

A personal line of credit (LOC) is a revolving, open-ended consumer loan. Unlike the previous two borrowing options we’ve gone over, your loan does not immediately end once you’ve finished paying off what you’ve borrowed. On top of that, you can either draw your entire available limit, or you can draw smaller amounts over time, as long as you have some available credit and your account remains in good standing. Additionally, you’ll only be charged interest and/or fees on the amount you’ve borrowed, not the entire credit limit.

Person sitting on the floor researching a consumer loan on their laptop.

A line of credit can be used for a number of different things depending on the type of LOC you’re looking for, but it’s often used as a safety net when you’re facing an emergency expense and don’t have the savings to cover it.

Mortgages

There’s a good chance you already know what these are, but in case you don’t, a mortgage is a consumer loan that you apply for in order to help you buy a home. Generally, you’ll put forth a relatively small percentage of the total cost of the home in the form of a down payment, and the rest of the balance is paid for through a mortgage given by a financial institution.

While there are different kinds of mortgages out there, they all help you accomplish the same thing, which is to buy a home. The type of mortgage can dictate how big of a down payment you’ll need and can also impact what credit score you’ll need to have in order to be approved.

The term of a mortgage can vary, but it will typically be either 15 or 30 years.[1] The relatively long nature of the repayment period stems from the fact you’re borrowing such a substantial amount of money. A mortgage can either have a fixed rate, meaning you’ll pay interest at the same rate throughout the duration of the loan, or an adjustable rate that may fluctuate over the years.

Credit Cards

As we mentioned before, credit cards are one of the most common types of consumer loans out there. It essentially acts the same way as a line of credit, where you’ll be approved for a specific max loan amount and can borrow money up to that amount as long as you have available credit and your account is in good standing. Keep in mind that interest rates on credit cards are generally fairly high, but you’ll only pay interest on what you borrow. As long as you’re paying everything off by your next due date, you won’t be charged interest.

Auto Loans

You may have already guessed it, but an auto loan is meant to help you purchase a car. Generally, these loans are secured, and the collateral you’re putting up to secure them is the car itself. If you end up defaulting on your loan, the financial institution can take the car as payment.

The terms of these loans will vary, but they act similarly to consumer installment loans in that you’ll pay off your loan along with the applicable charges in a series of fixed, scheduled payments.

Student Loans

Smiling student thinking about a consumer loan.

We all know that an education often doesn’t come cheap, which is what leads people to need student loans to pay for their college degree. These loans will often be given out by the Federal Government, and generally come with lower rates than many of the other consumer loans on this list. There are a few different reasons for this, like:

  • Student loans may be subsidized by the government.
  • They can be seen as relatively low risk by lenders because the completion of a degree (particularly in certain fields) can indicate that you’ll have the income to pay off your loan.

In some cases, you won’t need to start paying these loans off until you’ve completed your degree.

Consumer Lending is All Around You

As you can see, a consumer loan is a fairly broad category that houses loans for all sorts of different scenarios. They can help you buy a car, a home, fund your education, and even help you with emergency expenses.

Just remember that before you apply for a loan of any type, make sure you do these things:

  • Consider why you’re thinking of applying for a loan and ask yourself if you really need one.
  • If you are going to apply, make sure you’re applying for the type of loan that is meant for your particular needs.
  • Do your research into different lenders and compare rates and terms.
  • Always make sure you can afford a loan before applying for one.

Overall, always be prudent when borrowing money and make sure to do your research!

 


 

[1] https://www.investopedia.com/terms/m/mortgage.asp


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