The term "consumer loan" may sound foreign to you, but chances are you already borrowed one because many loans you take to fund your various purchases and events fall into that category. Since consumer loans make up most of the loans available to you, it is crucial to understand their operations, benefits, and how to get them.
Here is a detailed discussion of consumer loans, including their types, uses, categories, and an ultimate guide to help you make an informed decision when taking your next loan. Read through!
What is A Consumer Loan?
A consumer loan is a type of lending product consumers use to finance specific expenses, from everyday shopping to significant purchases like house acquisition. Simply put, it is a loan that a financial institution lends you to pay for a product or service.
In addition to funding purchases, consumer loans are used to refinance a debt burden. That entails a borrower taking out a consumer loan at a cheaper interest rate to cover a previous debt whose late repayment could attract serious finance charges.
The eligibility for consumer loans usually varies from lender to lender. However, the general qualification requires the borrower to be within the age range of 21 to 60 or 65. Borrowers above 60 years are past retirement age but must be self-employed to qualify for a consumer loan.
To borrow consumer loans, lenders usually require some documents to prevent fraud and verify your claims before granting borrowing requests. Such documents are:
A proof of identity: All lenders usually ask for an ID before processing a loan. The means of identification could be your driver's license, SSN, birth certificate, utility bills, passport, citizenship certificate, or state ID.
Proof of income: Lenders usually check bank statements, payslips, tax returns, alimony proof, and other documents verifying your income source before offering you a loan. They need to be sure that you have enough cash for down payments and can pay back the loan you want to borrow.
Proof of Address: Lenders usually confirm that the address on your bank statement matches the one on the ID and other documents tendered.
Other documents: You may need supporting documents other than the ones already listed in the categories above. In any case, the lender will let you know what files are acceptable.
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6 Common Types Of Consumer Loans
As stated earlier, most of the loans available to you fall under the consumer loan category. For clarity, here are six of the most common consumer loans and what they entail:
A mortgage is a secured loan used to buy or maintain a home and other real estate properties. Since house price tags can be quite hefty, mortgages allow you to pay for your dream home over time. So, instead of paying the entire price on purchase, you pay in installments until the debt gets cleared and you own the property.
Mortgages always come with interest rates which you have to repay alongside the loan amount over the repayment period, usually 15 to 30 years.
Borrowers are usually expected to make monthly payments during the agreed loan term. The collateral in this type of secured loan is the home itself. That means the lender can sell off the property when you default on the monthly payments to recoup their loss.
There are different categories of mortgage loans. By term, home loans can stretch between 5 to 40 years. However, the most common loan terms are 15 and 30 years.
Mortgage loans are also classified into specific programs
- Federal Housing Administration (FHA) Loans:
These are loans tailored to meet the home purchase needs of borrowers who have difficulties securing funding from private loan companies. FHA loans are insured by the government and offered only by approved financial institutions. Recipients are usually average families and first-time home buyers.
- U.S Department Of Agriculture (USDA) Loans:
USDA loans is a mortgage program created for people living in rural areas. The aim is to help low-income households escape substandard rural communities and move to a much better location.
These loans can either be from an approved commercial bank or the government. They usually require no downpayments from qualified borrowers.
- U.S Department Of Veterans Affairs (VA) Loans:
The VA loan program allows service personnel, veterans, and their spouses to take home loans. It usually requires little or no down payments with reasonable interest rates to reduce the borrower's debt burden. VA loans are issued by private loan companies and backed by the government.
Other popular types of mortgage include:
Fixed-rate Mortgages: Also called traditional mortgages, these home loans have a fixed interest rate and monthly payment throughout the loan term.
Adjustable Rate Mortgages: ARMs have a fixed interest rate at the start of the repayment period and for some time. However, the rate may change based on the market value during repayment.
Average Mortgage Rates 2022
The cost of a mortgage loan varies from lender to lender but usually depends on several factors, including the repayment term, interest rate, discounts, and other fees.
According to the stats released by Bankrate as of December 12, 2022, these are the average mortgage rates according to different loan terms.
|Loan term||Mortgage Rates||Example|
|15-year fixed rate mortgage||6.07%||$10000 mortgage at 6.07% interest rate costs $848 monthly (principal plus interest). Total interest throughout the 15 years will be $52,640.|
|30-year jumbo mortgage rate||6.83%||$750000 mortgage at 6.83% interest rate costs $4909 monthly (principal plus interest). Total interest throughout the 30 years will be $1,017,240.|
|30-Year fixed rate mortgage||6.81%||$10000 mortgage at 6.81% interest rate costs $653 monthly (principal plus interest). Total interest throughout the 30 years will be $134,933.|
Credit cards are cards issued by financial institutions that give the holders access to a line of credit.
Such cardholders can either use the standard line of credit, which allows them to use the card to pay for goods and services or borrow cash advances that are accessible via ATMs, cheques, or bank tellers using the Cash Line of Credit.
The main difference between the standard line of credit and the cash line of credit is that the latter allows cardholders to withdraw borrowed cash while the former only allows them to pay with their credit card.
Cash lines of credit usually have higher interest rates and no grace periods. However, the terms can be different, depending on the card issuer.
The borrower of either of the two lines of credit is expected to repay the advances alongside the credit card company's fees before the next due date. If someone does not pay before the billing date, interest will accrue on the loan. Depending on the issuer, the rates can accrue daily or monthly for about one month after borrowing.
If your rates accrue daily, the total accumulated interest will likely be higher than that of the monthly accrued card. That is why you should always check whether a credit card company's interest is issued daily or monthly before applying for their card.
Credit Cards come in various forms. Some of them are:
- Reward credit cards: Issuers of this card offer bonuses, like cash back, points, groceries, travel, dining out, and gas rewards when you pay for your expenses with your credit card.
- Student credit cards: As the name implies, the card is tailored for young people, mostly students with limited credit history. It has several perks, like zero annual fee, easy approval, and extra bonuses on spending.
- Secured credit cards: People with bad credit usually apply for a secured credit card because it allows collateral tendering. Before receiving a line of credit, you must deposit the required amount. Your credit card limit can be very low when you apply for a secured credit card.
- Business credit cards: These cards are solely for business owners who wish to separate their personal and business expenses. Business credit cards can be secured or reward credit cards.
- Store credit cards: These are cards issued by retail store owners to their customers to enable them to pay their bills over a period. They usually charge a higher interest rate than other types of credit cards.
An auto loan is a consumer loan type that enables you to borrow cash from a lender to purchase a vehicle.
It makes buying a car easier by allowing you to pay for it in bits. Like most loans, you will be required to pay back an auto loan in installments with an interest rate that may be fixed or adjustable. The interest rate for auto loans mostly depends on your credit score- the higher your credit score, the lower the interest rate charged, and vice versa.
Your credit score plays a huge role in determining whether or not you will be considered for an auto loan. The ideal score to secure an auto loan is 700 or higher. However, if your credit score is 580 or greater, you should get a few offers too. Anything less than 580 will make it challenging to secure a loan, so you should endeavor to raise it before applying.
Most auto loan lenders tailor their installment plans to your financial status because the point of the loan is to allow ease of payment. Nevertheless, you should compare several offers before selecting the one that best suits your financial situation.
Auto loans are available in various types. Your financial status, loan amount, credit score, vehicle type, and loan term determine which is best for you. See the major types of auto loans you can get below.
- Dealer Financing
- Bank or Credit Union Financing
Banks or credit unions give auto loans directly to qualifying borrowers. You can go to them directly instead of using a dealer, but approval time generally takes longer.
The lender will approve a specific loan amount and give you a quote and a letter of commitment which you will give to the dealer. That helps you escape extra expenses in the form of add-ons that the dealer may try to persuade you to get.
Bank or credit unions charge interest rates on auto loans without adding a markup. That means the cost of borrowing should be less than going through dealers who charge extra as their gain.
- Online Auto Loan Financing
While you can go to traditional banks or financial institutions to preapprove a loan, you can also apply for an auto financing loan online.
All the document submissions and processing happen remotely, and the approval is usually done within a business day. However, your loan processing may take longer if your credit score does not qualify for the loan, and you need to tender other ways to analyze risk.
- Auto Refinance Loans
An auto refinance loan is a loan offered mostly by private lenders that you can take to cover an existing loan. It usually has a different term better than the former loan.
Some of the benefits include a lower interest rate, shorter loan terms, and decreased monthly payments. But usually, it needs a higher credit score.
- Cash-out Refinance Loans
The cash-out refinance loan is similar to the regular auto refinance loan because it is used to replace an existing one.
The only difference is that cash-out auto refinance allows you to convert your car's equity into cash and borrow it. The equity amount borrowed is then rolled into your refinance loan. Generally, the refinance loan offers a lower interest rate and better terms, but you will still pay more throughout the loan term.
Auto retailers offer car purchase financing to borrowers who seek an auto loan. That way, the retailer can sell off a vehicle faster rather than wait for the buyer to arrange their financing.
After approving the loan, the dealer sells the loan to a financial institution at a discount and sends the borrower's details. When the borrower pays such a loan, it goes to the bank or financial institution as they have already bought the loan.
Although dealer financing makes it easy for you to shop and secure financing in one spot, the interest rate is usually higher than the other auto loan financing methods. That is because the dealer adds their commission called markup, to make a profit before matching you up with a financial institution.
Nevertheless, dealer financing has its perk, as it can help you secure a promotional discount from the vehicle's manufacturer if the retailer is a recognized seller.
Student loans are funds you can borrow from the government or a private lender to finance your college. Schools usually offer loans as part of their financial aid programs. Interested students can apply for loans but must pay them back with interest.
Before taking a student loan, it is crucial to understand its terms. Generally, loans from the federal government are more beneficial than those offered by private lenders. Federal government loans are available in four types:
Direct Subsidized Loans: These are special loans offered by the federal government to students who need dire help with paying their college fees.
You have to meet the requirements to qualify for the direct subsidized loan. Eligibility is determined by subtracting school attendance cost from the expected family contribution. If you qualify, the government will pay back the interest from disbursement time to the start of the repayment term.
Direct Unsubsidized Loans: These loans are the opposite of subsidized loans. You will be responsible for the interest from the disbursement time to complete repayment. That means your installments will include the principal and interest from the onset.
Direct Plus Loans: The Direct Plus Loans are tailored to help parents of dependent students and graduates pay for tuition not included in other financial aids. Applying requires a credit check - unqualified people must meet extra requirements to become eligible.
Direct Consolidation Loans: These are a combination of all the federal loans available to you. It can include two or three of the earlier-mentioned loan types.
As stated earlier, student loans are also offered by private lenders. Private student loans usually cost more than the federal government direct offers.
There is no subsidized loan under this student loan- you have to cover all the interest without help from the government. Also, students who borrow from private lenders have to start paying back the loan even while still in school.
Personal loans are probably the most common type of consumer loan because of their varied use. Banks, online lenders/brokers, and credit unions offer personal loans to borrowers to cover different purposes, from home renovation to debt consolidation.
Personal loans usually come with interest rates that vary from lender to lender. The interest rate is meant to be paid alongside the principal amount throughout the repayment term.
The repayment term on a personal loan is the period during which a borrower is allowed to pay back a debt. Usually, the repayment term comes with a plan that divides the total debt into bits for ease of payment. If you follow through with the plan without missing a payment, your debt should be paid up by the end of the loan term.
There are two types of personal loans- Secured and unsecured.
Secured loans: A secured loan requires collateral before approval. Collateral can be anything, from cash assets like a savings account to a physical asset, like a building, as long as it is valuable.
Such collateral is the security for the loan borrowed. That means when you default on repayment, the lender can claim the item(s) and sell them to recoup their loss.
Unsecured loans: Unsecured loan lenders don't accept collaterals like secured loan companies. They usually do risk assessments by checking the borrower's credit score, debt-to-income ratio, income, credit history, and more.
Before accepting a personal loan offer, you should read and understand the terms, as some conditions can be very unfair. Check the interest rate, APR, repayment terms, borrowing limit, loan type, and other fees before signing a deal.
Refinance loans are a review of an existing loan. This simply entails the borrower negotiating the terms of an already approved and ongoing loan with the lender. If the lender agrees, they replace the conditions of such a loan and draft a new contract. That new agreement is called a refinance loan, as the original terms no longer guide the deal.
Most borrowers ask lenders to revise the terms of a loan when the market value of the interest rate falls. That allows them access to a more lenient borrowing time, especially on the loan's interest rate. Other reasons a borrower can ask for a loan term review are:
A change in credit score: Lenders usually charge a higher interest rate if a borrower's credit score is low. So, if such a borrower's credit score improves during the loan term, they may request an adjustment to cut down the interest rate.
Switch interest type: A borrower may wish to change the interest charge from adjustable to fixed rates or vice versa. That may help reduce the total loan cost in the long run.
Before you can access a refinance loan, you ought to send a request to review the conditions to your lender and fill out another loan application form. The lender will then assess your finances again to determine whether you are eligible for a loan term review.
Depending on your lender, the following types of refinancing loan options are available on consumer loans:
Rate and term refinancing: This simply involves replacing your existing loan with a new one. It entails the review of the interest and the terms of payment to access lower rates and speed up the loan payment. Rate and term refinancing usually reduce the cost of the loan over time.
Consolidation refinancing: This type of refinancing option entails paying off an existing loan with a new one that has a lower interest rate. That helps the borrower repay the costlier loan and roll over the outstanding balance into a low-interest debt.
Cash-In refinancing: Normal loan terms spread across the repayment term; however, you can reduce the installment payment amount and even the loan term when you cash in a lump sum.
Cash-in financing entails paying a lump sum to pay off a large part of your debt and replacing it with a smaller loan amount. This can go a long way in reducing the total interest on the loan.
Cash-out refinancing:Cash-out refinancing entails the borrower selling the equity on their collateral, usually when its value increases while they are still paying off the initial debt.
After selling the equity, the borrower takes another loan from the lender to retain the ownership of the property. The perk of this refinancing is that the borrower will have access to cash; however, the new loan is usually higher and costs more than the initial debt.
Categories Of Consumer Loans
There are two categories of consumer loans- Open-end and Closed-end Loans.
An open-end loan is also called a revolving credit or line of credit. It is a preapproved loan that a borrower can keep drawing from until they reach the set limit.
Such a borrower has to pay that loan plus the charged interest before the due date. Failure to repay by the set date will attract more fees on the line of credit used. Open-end loans are usually unsecured loans.
A very common example of an open-end loan is a credit card. Borrowers have access to funds until they reach the set limit and must pay back the used line of credit and the interest on or before the due date to avoid additional charges.
A closed-end loan is also called an installment credit because of its operation. It is a loan used to finance a particular purpose.
After getting the loan, the borrower is expected to pay back the total amount plus the interest and other charges in equal installments before the repayment period lapses.
It differs from an open-end loan because the borrower cannot keep drawing cash after settling the initial debt. The cost of the closed-end loan is usually determined by the borrower's credit score.
An example of a closed-end loan is the auto loan. Once you borrow a lump sum to purchase a car, you must pay off the debt in installments before a set date. Failure to repay will attract more fees, and eventually, the lender can claim the car to sort losses.
What is the difference between Secured and Unsecured Consumer Loans?
Secured consumer loans
A secured consumer loan is backed by collateral. When a borrower takes this type of loan, they tender a valuable asset, from liquid to physical, as a security for the amount they borrow.
Such a person must repay the loan amount plus interest and other fees before the repayment period lapses. If the borrower defaults, they forfeit the collateral to the lender, who can sell it to regain the loan amount. Usually, the lender ensures that the collateral is equivalent to the loan amount to maintain fairness.
An example of a secured customer loan is a mortgage or home loan. The home is the collateral in this case, so when the borrower defaults, it is claimable by the lender.
Unsecured consumer loans
An unsecured loan is the exact opposite of a secured consumer loan because collateral is not required. Instead of asking for collateral, the lender checks the borrower's credit score, income, debt-to-income ratio, and credit history, among others, to see if they qualify for a loan.
An example of an unsecured consumer loan is a student loan. Lenders do not ask for collateral before granting student loans. They approve the loan and collect a percentage as interest.
How to Find the best lender for Consumer Loans
To secure the most suitable consumer loan for your needs, you need to compare all the offers from lenders. Look out for the following when comparing the offers:
Interest rate and APR
Interest rate is a percentage of the principal (loan amount) that lenders charge as a fee, while the APR includes the interest rate plus additional fees.
The offer with the lowest rates is the best for you. Most of the time, your credit score affects the rates you get. A low credit represents a greater risk, so the lenders will most likely charge an outrageous amount.
Also, check the type of interest that the lender is offering. If it is fixed, the rate will remain the same throughout, and if it's adjustable, the rate will change during the loan term.
The repayment term is the duration of a loan. Lenders can offer a long or short repayment term, depending on what type of loans you take. Mortgages can last up to 40 years, while personal loans usually last 7 years.
While long loan terms may seem attractive because of the smaller installments, they usually attract higher interest rates over time. Conversely, smaller loan terms cost less than loans with long repayment terms.
Ensure you select a plan that you can afford to avoid attracting penalties for late repayment or defaulting.
Some lenders charge additional fees apart from the interest rate. You must check the fees applicable to the offer to avoid unnecessary billings. Some common fees lenders charge are:
- Origination fee: This is also called the processing fee. It is a percentage of the loan amount, usually 0.5% to 1%, that the lender charges upfront to process your loan. The fee gets deducted from the loan itself before you get deposited.
- Late payment fee: This is the amount that the lender charges for missed payments. It is crucial to check the late payment fee, especially if you tend to default.
- Prepayment fee: Some lenders charge penalties for early repayment because it deprives them of making more gains. Check this fee if you can repay before your loan term ends.
The monthly payment in a loan offer is the amount you are supposed to pay as monthly installments throughout the repayment term. It comprises the principal, interest rate, and any additional fees the lender may charge. Check the amount available on each repayment plan to ensure you can afford it.
Collateral or not
It should be stated clearly in the loan offer whether the lender is offering a secured loan or not. Secured loans require collateral, while unsecured do not.
With a good credit score, you will hardly need collateral, but bad credit may require one for security. Check what type of loan they offer and if it suits your preference and financial status.
The Benefits of Taking Out Consumer Loans
Borrowing consumer loans has several perks. Some of them are:
- It helps to diversify your credit history. This shows the credit bureaus how well you can handle different credit types and increase your chance of improving your credit score.
- Some consumer loans offer the best interest rates and high loan limits. That helps to reduce the debt you will pay over time and borrow as much as you need.
- Personal loan, a consumer loan, is great for debt consolidation. You can reduce your debt by taking a loan with smaller interest to pay off the existing one.
- Approval time for some consumer loans is pretty quick.
- Consumer Loans allow you to access funds quickly in case of emergency expenses.
1. What are the Differences Between Commercial Loans and Consumer Loans?
|Consumer loan||Commercial loan|
|Consumer loan does not usually require a guarantor.||Usually requires the signature of authorized personnel in the business.|
|Lenders only check the documents belonging to the borrower.||Lenders check the business's financial statement and credit report.|
|It is tailored for consumers.||It is designed for businesses, including firms, corporations, and organizations.|
|Loan terms are usually longer.||Loan terms are usually shorter.|
2. Is a Consumer Loan the Same as a Personal Loan?
A personal loan is a loan type classified under consumer loans.
While personal and consumer loans have similarities, they also have some disparities. Therefore, you cannot use both terms interchangeably, as the former is a subclass of the latter.
For instance, both loan types can be secured or unsecured, but they still have the following differences:
Consumer loans can be open-end or closed-end, while personal loans are closed-end. That means consumer loans can lend borrowers money as a line of credit, lump sum, or specific purpose loan, while personal loans can only lend borrowers a lump sum.
- The federal government and financial institutions offer consumer loans, while financial institutions only offer personal loans.
Consumer loans include typical loans, like mortgages, auto loans, personal loans, credit cards, student loans, and refinance loans. Each has its terms and conditions, but they all have one purpose; to enable consumers to make large purchases easier and faster.
Of all the consumer loan types, personal loans are our favorite because they cost less and are readily available to borrowers with or without a good credit score.
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