What are the different types of loans?

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November 26 2019
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Applying for a loan is one of the ways in which you may access a large sum of money from lenders, but applying for the right type is important.

Different types of loans

There are a variety of loan products from different lenders that both consumers and businesses may access, and they may be categorised as any of the following:

Open-end and closed-end loans

Open-ended loans are loans or debt products that allow you to repeatedly borrow money whenever you need it as long as you don’t exceed the credit limit. Examples of this include credit cards and lines of credit.
Closed-ended loans are debt products that you can only receive once for a particular application – and you typically can’t borrow the same loan for a second time until the first is repaid in full. Likewise, you’ll be required to pay a fee if you break any of the loan’s terms.

Secured and unsecured loans

Secured loans require you to put up an asset or have a guarantor to back up your loan.
You may use the asset you purchase with the loan or any other asset you own that is of similar value as collateral. The downside is that the lender has the right to take the asset in the event that you default on the loan.

On the other hand, a guarantor would be forced to make repayments or pay off your debt on your behalf.
Unsecured loans don’t require collateral or a guarantor – your creditworthiness is the biggest factor in getting approved for one.
Unsecured loans are usually more difficult to get approved for and have high interest rates.

Small-business loans
Financial institutions offer business loans that could meet your needs, but they usually have strict qualifications for start-ups and small- to medium-sized enterprises (SMEs).

For more information on this, read “Our guide to the 8 most popular types of loans for SMEs”.

Alternative financing
Alternative financing refers to loans that are not provided by institutional lenders.

Borrowers have a higher probability of getting approved for a loan regardless of their credit score – alternative lenders are more lenient with requirements.

Examples of alternative financing are no-interest loans (NIL) and peer-to-peer (P2P) lending.

NILs are typically offered by not-for-profit organisations to low-income earners who require funding to meet specific needs.

On the other hand, P2P lending refers to a platform wherein other individuals willingly lend their money to other people who pay them back with interest.

What types of loans need a guarantor?

Secured loans typically require a guarantor to assure the lender that they can recoup any potential loss should you fail to make repayments or default on the loan.

However, a guarantor isn’t usually required if the borrower has a good credit rating, stable source of income and can prove that they are able to repay the debt without a third party.

What types of loans should you pay off first?

Assuming you have multiple debts, there’s really no specific type of loan that must be paid off first – it all depends on your debt repayment strategy and potential need.

There are several strategies you may use to pay off your debt, but the most popular strategies focus on the balance and interest rates.

Pay off the lowest balance first
If you want to see immediate rewards for your debt repayment efforts, you may consider paying off the debt with the lowest balance first.

This is how this strategy works:

You need to make minimum repayments on all your debts, but you’ll also keep on making additional payments on your debt with the lowest balance. Once you pay off this debt in full, proceed to do the same thing with the next lowest balance.

The goal here is to completely remove debts in the fastest time possible by making extra repayments to the “easiest” debt to pay off. This way, your successes will be immediate.

Pay off highest interest first
If you want to slow down the growth of your debt due to compound interest, consider paying off the debt with the highest interest rate first.

Here’s how this strategy works:

Similar to the previous strategy, you’ll pay the minimum on all your debts. But this time, you’ll make extra repayments on the debt with the highest interest rate.

Doing this can save you money in the long run because your interest payments will have a lower chance of growing quickly.

It may be more ideal to pay off high-interest debts first to stop your debt from potentially inflating, but the decision still rests on your objectives and circumstances.

How is interest calculated on a loan?

To estimate the amount of interest you will potentially pay on a loan each payment period, you need to know your interest rate and the frequency of payment (i.e. monthly, fortnightly, etc.).

For the first payment, you may use this formula:

Interest = loan principal x (interest rate per annum ÷ number of payments)

For succeeding payments wherein a portion of the principal loan amount has been paid off, you need to compute for your new balance using this formula:

New balance = loan principal - (previous repayment - interest)

And with your new balance, use the first formula again.

Alternatively, you may use Smart Property Investment’s mortgage principal and interest calculator.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

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