Many people use loans to finance purchases. Loans can be used to finance real estate purchases, vehicles, education, and more. They can also fund a business’s operating costs and expenses.

There are many different types of loans. Let’s look at some of the most common and how they work.

What is a loan, and how does it work?

Loans are a way to finance purchases and investments. When a bank lends money to a person or company, it is called a loan. The lender agrees to give you the money in exchange for repayment of the loan principal amount plus interest. Each party agrees to the loan terms before any money is advanced. A loan may be secured by collateral or unsecured.

Types of loans

  • Secured and Unsecured– Secured loans are loans backed with something of value that you own, called collateral. Common examples of collateral include your car or other valuable property such as jewelry. An unsecured loan means that the borrower does not have to offer any asset as collateral.
  • Open-end and closed-end loans -With an open-ended loan, you have the freedom to borrow over and over. Lines of credit and credit cards would be examples of open-ended loans. You cannot borrow again with a closed-end loan until the loan is repaid.

What is an installment loan, and how does it work?

Installment loans allow you to borrow money and pay it back in equal monthly payments with a fixed interest rate. The interest rate can depend on several factors, including the loan size, the applicant’s credit profile, and whether collateral is pledged, and repayment terms can range from a few months to over 30 years.

Types of installment loans

  • Auto loans– are secured loans with fixed payments for terms ranging from 12 to 96 months. As long as you make your full scheduled payment installments on time, your car loan is paid in full at the end of your term.
  • Mortgage loans– These are sometimes variable-rate loans where the interest rate changes during the loan term are used to buy a home.
  • Personal loans– are used to consolidate debt, pay for large purchases, or cover unexpected expenses like car repairs, medical bills, or home repairs.

The Bottom Line

Loans of all types meet specific financial needs, like debt consolidation, major purchases, and unexpected expenses. An installment loan could give you the money you need with a repayment schedule that fits your financial situation.

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