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Types of loans (& how to get them)

At a glance:

  • Business loans

  • Consumer loans

  • Installment loans

  • Real estate loans

  • Financial institution loans

  • Lease financing: Here are the basics

  • Summary of Types of Loans

The money that consumers and businesses place in banks, savings and loans, and credit unions does not sit idle. These institutions lend money to a wide variety of borrowers for a wide variety of purposes.

The fact that money can be recycled through lending keeps the economy strong and growing. Individuals use borrowed money for consumer goods. Businesses use borrowed money to expand operations. In general, borrowed money fuels the economy.

However, too much borrowing and failure to repay can be very dangerous. A wise investor knows the pros and cons of borrowing and keeps it in check.

Benjamin Philip, 23, a graduate in engineering from The City College of New York poses for photos with his family at his commencement ceremony in Manhattan on May 31, 2019. When asked about student debt he said, "If tuition could be free, that would be best. I feel like I will be able to pay back my loans with my new job." REUTERS/Gabriela Bhaskar
Student loans are just one type of loans. (Photo: REUTERS/Gabriela Bhaskar)

Business loans

Financial institutions loan funds to businesses for many different purposes. A corporation may need capital to finance the acquisition of another company. The acquired company may provide the cashflow needed to repay the loan, provide assets that could be sold for profit, generate more earnings with improved management, or in other ways enhance the market value of the purchasing company's stock.

An institution may also loan funds to a business for projects such as bringing a new product to market or expanding market share. Some projects, such as mining, oil refining, or large industrial plants, may require a long-term loan of many years.

Working-capital loans

In contrast, working-capital loans provide short-term funds (usually a year or less) designed to keep a business operating. For example, a business may need a loan to buy raw materials or purchase inventories. Sometimes working-capital loans are made to businesses that are seasonal in nature. A retailer may need to purchase inventories in August and September to sell during the winter holiday season.

In addition to retailers, common borrowers include farmers, who may purchase seed and other supplies in the early spring and then repay the loans after harvests. In fact, most industries and commercial ventures borrow funds either occasionally or routinely.

Consumer loans

Consumer lending (particularly credit cards) is very profitable for lenders.

Who takes out consumer loans?

In contrast to business loans, individuals – not organizations – borrow through consumer loans. People borrow money for several different reasons. They may need to buy a car, replace an appliance, finance a vacation, or pay their children's college tuition.

Banks, savings and loans, and credit unions also make loans for home additions and other residential property improvements. The amounts loaned are also generally smaller than those made available for business.

Installment loans

Most borrowers take advantage of installment loans. These loans allow the borrower to repay the lender in repeating monthly payments, with either a fixed or floating interest rate. Each payment is a combination of principal and interest, although if consumers make the minimum payment amount each month, only a small portion will go toward principal.

Another type of loan is the short-term (usually six months or less) non-installment loan. Principal and interest are repaid in one lump sum upon maturity. A consumer may use a non-installment loan to pay for home repairs, a vacation, medical care, or other immediate needs.

Real estate loans

Real estate loans include home mortgages, home construction loans, and loans to acquire various business properties. They also may include any improvements to physical properties, including additions, landscaping, parking lots, dividing and opening up rooms within a building, and adding such fixtures as fireplaces and swimming pools.

Who takes out real estate loans?

Borrowers who take out real estate loans may be individuals purchasing single-family homes. They may be developers, seeking to build a shopping center, hotel, or office building. Or they may be investors seeking to purchase a particular income property.

Two types

There are two basic types of real estate loans:

  • Short-term construction loans. These generally are for a period of a few months or so, during the construction of a home, office, or other building.

  • Long-term mortgage loans. A mortgage loan may stretch out to 30 years (40-year mortgages do exist, but they are not offered by every lender), essentially providing permanent financing for the acquisition of the property.

Financial institution loans

Banks, credit unions, and other lenders – especially those with more than $300 million in assets – sometimes make loans to other financial institutions.

Typically, the amount of these loans is a relatively small percentage (less than 5%) of the lender's loan portfolio. The need for these loans varies from community to community and from region to region.

Why do they make institutional loans?

Lenders make loans to financial institutions for some of the same reasons they make loans to consumers, farmers, businesses, and other borrowers. They make loans to support their communities with an adequate supply of funding for consumption and investment activities and to promote the region's economic vitality.

Lenders are interested in loaning funds to other financial institutions because they will receive interest payments, and the risks associated with lending to another financial institution are generally lower than lending to consumers and small businesses.

By supporting other financial institutions in the area, lenders increase their positive impact on new business growth, job creation, and other components of a strong economy.

Lenders may also make loans to finance companies, insurance companies, and savings and loan institutions.

Lease financing: Here are the basics

In lease financing, a financial institution buys many different types of fixed assets, such as vehicles or equipment, and then leases them to business customers. Generally, the institution does not provide lease financing services to individual consumers in the same way that it provides these services to business customers. The auto industry has taken advantage of lease financing arrangements and has been instrumental in finding lessors to provide lease financing for vehicles to individual consumers.

How it works

Here is how it works: a business customer (lessee) will enter into a contract with the financial institution (lessor) to use one or more items. In exchange for using an item, the customer makes regular payments to the lessor.

The contract spells out the amount and schedule of payments, responsibilities for repairs and maintenance, and how long the agreement will remain in effect. At the end of this term, some contracts permit the customer to purchase the item for a specified amount.

Financial institutions may provide lease financing for many different items, including trucks, vans, cars, and other vehicles; as well as equipment such as computers, furniture, machinery, fax machines, and copiers.

Summary of types of loans

Banks, savings and loans, credit unions, and other lenders make loans to support all areas of economic endeavor – production, consumption, and investment. Commercial, consumer, and real estate loans help businesses and individuals achieve goals and stimulate purchasing.

Loans to other local financial institutions and equipment leasing help local businesses operate. Overall, banks, savings and loans, credit unions, and other lenders provide the underpinnings of a healthy economy.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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