Practitioners commonly refer to four distinct loan types: asset-based loans, cash flow loans, trade financing, and leasing. It is important to account for these differences in loan type in order to analyze the economic significance of credit market disruptions.

Borrowed money can be used for many purposes, from funding a new business to buying your fiancée an engagement ring. But with all of the different types of loans out there, which is best—and for which purpose? Below are the most common types of loans and how they work.

• What are the Types of Bank Loans?
• What is Lending?
• How does Lending Works
• What are the different Types of Lending?
• What are some Types of Lenders?
• What is a Loan from a Bank?
• What is the Difference Between Lending and Borrowing?
• How can I get Approved for a Loan?

What are the Types of Bank Loans?

Personal Loans

Most banks, online and on Main Street, offer personal loans, and the proceeds may be used for virtually anything from buying a new 4K 3D smart TV to paying bills. This is an expensive way to get money, because the loan is unsecured, which means that the borrower doesn’t put up collateral that can be seized in case of default, as with a car loan or home mortgage. Typically, a personal loan can be obtained for a few hundred to a few thousand dollars, with repayment periods of two to five years.

Read Also: What are the Major Types of Loans?

Borrowers need some form of income verification and proof of assets worth at least as much as the amount being borrowed. The application is typically only a page or two in length, and the approval or denial is generally issued within a few days.

Best and worst rates

The average interest rate for a 24-month commercial bank loan was 10.21% in the fourth quarter of 2019, according to the Federal Reserve. But interest rates can be more than three times that amount: Avant’s APRs range from 9.95% to 35.99%. The best rates can only be obtained by people with exceptional credit ratings and substantial assets. The worst must be endured by people who have no other choice.

A personal loan is probably the best way to go for those who need to borrow a relatively small amount of money and are certain they can repay it within a couple of years. A personal loan calculator can be a useful tool for determining what kind of interest rate is within your means.

Bank loan vs. bank guarantee

A bank loan is not the same as a bank guarantee. A bank may issue a guarantee as surety to a third party on behalf of one of its customers. If the customer fails to fulfill the relevant contractual obligation with the third party, that party can demand payment from the bank.

The guarantee is typically an arrangement for a bank’s small-business clients. A corporation may accept a contractor’s bid, for example, on the condition that the contractor’s bank issues a guarantee of payment in the event that the contractor defaults on the contract.

Credit Cards

Every time a consumer pays with a credit card, he or she is taking out a personal loan. If the balance is paid in full immediately, no interest is charged. If some of the debt remains unpaid, interest is charged every month until it is paid off.

The average credit card interest rate carried a 16.88% APR at the end of the fourth quarter of 2019, according to a the Federal Reserve—down slightly from the 2019 second quarter rate of 17.14%, but almost exactly where it was (16.86%) at the end of the fourth quarter of 2018. Penalty rates, for consumers who miss a single payment, can get bumped even higher—for example, to 31.49% on at least two of HSBC’s Mastercards.

Revolving debt

The big difference between a credit card and a personal loan is that the card represents revolving debt. The card has a set credit limit, and its owner can repeatedly borrow money up to the limit and repay it over time.

Credit cards are extremely convenient, and they require self-discipline to avoid overindulging. Studies have shown that consumers are more willing to spend when they use plastic instead of cash. A short one-page application process makes it an even more convenient way to get $5,000 or $10,000 worth of credit.

Home-Equity Loans

People who own their own homes can borrow against the equity they have built up in them. That is, they can borrow up to the amount that they actually own. If half of the mortgage is paid off, they can borrow half of the value of the house, or if the house has increased in value by 50%, they can borrow that amount. In short, the difference between the home’s current fair market value and the amount still owed on the mortgage is the amount that can be borrowed.

Low rates, big risks

One advantage of the home-equity loan is that the interest rate charged is far lower than for a personal loan. According to a survey conducted by ValuePenguin.com, the average interest rate for a 15-year fixed-rate home equity loan as of Feb. 5, 2020, was 5.82%.

As a result of changes in the 2017 Tax Cuts and Jobs Act, interest on a home equity loan is now only tax deductible if the money borrowed is used to “buy, build, or substantially improve the taxpayer’s home that secures the loan” per the IRS.5

The biggest potential downside is that the house is the collateral for the loan. The borrower can lose the house in case of default on the loan. The proceeds of a home equity loan can be used for any purpose, but they are often used to upgrade or expand the home.

A consumer considering a home-equity loan might keep in mind two lessons from the financial crisis of 2008-2009:

• Home values can go down as well as up.
• Jobs are in jeopardy in an economic downturn.

Home-Equity Lines of Credit (HELOCs)

The home-equity line of credit (HELOC) works like a credit card but uses the home as collateral. A maximum amount of credit is extended to the borrower. A HELOC may be used, repaid, and reused for as long as the account stays open, which is typically 10 to 20 years.

Like a regular home-equity loan, the interest may be tax deductible. But unlike a regular home-equity loan, the interest rate is not set at the time the loan is approved. As the borrower may be accessing the money at any time over a period of years, the interest rate is typically variable. It may be pegged to an underlying index, such as the prime rate.

Good or bad news

A variable interest rate can be good or bad news. During a period of rising rates, the interest charges on an outstanding balance will increase. A homeowner who borrows money to install a new kitchen and pays it off over a period of years, for instance, may get stuck paying much more in interest than expected, just because the prime rate went up.

There’s another potential downside. The lines of credit available can be very large, and the introductory rates very attractive. It’s easy for consumers to get in over their heads.

Credit Card Cash Advances

Credit cards usually include a cash advance feature. Effectively, anyone who has a credit card has a revolving line of cash available at any automatic teller machine (ATM).

This is an extremely expensive way to borrow money. To take one example, the interest rate for a cash advance on the Fortiva credit card ranges from 25.74% to 36%, depending on your credit.6 Cash advances also come with a fee, typically equal to 3% to 5% of the advance amount or a $10 minimum. Worse yet, the cash advance goes onto the credit card balance, accruing interest from month to month until it is paid off.

Other sources

Cash advances are occasionally available from other sources. Notably, tax-preparation companies may offer advances against an expected Internal Revenue Service (IRS) tax refund. However, unless there’s a dire emergency, there’s no reason to give up part of your tax refund just to get the money a little faster.

Small Business Loans

Small business loans are available through most banks and through the Small Business Administration (SBA). These are typically sought by people setting up new businesses or expanding established ones.

Such loans are granted only after the business owner has submitted a formal business plan for review. The terms of the loan usually include a personal guarantee, meaning that the business owner’s personal assets serve as collateral against default on repayment. Such loans usually are extended for periods of five to 25 years. Interest rates are sometimes negotiable.

The small business loan has proved indispensable for many, if not most, fledgling businesses. However, creating a business plan and getting it approved can be arduous. The SBA has a wealth of resources both online and locally to help get businesses launched.

What is Lending?

Lending (also known as “financing”) occurs when someone allows another person to borrow something. Money, property, or another asset is given by the lender to the borrower, with the expectation that the borrower will either return the asset or repay the lender. In other words, the lender gives a loan, which creates a debt that the borrower must settle.

Simply put, lending allows someone else to borrow something. In terms of business and finance, lending often occurs in the context of taking out a loan. A lender gives a loan to an entity, which is then expected to repay their debt. Lending can also involve property or another asset, which is eventually returned or paid for in its entirety.

How does Lending Works

Lending occurs whenever a lender gives something to a borrower on credit. It’s a broad term that encapsulates many different kinds of transactions.

Common lenders include financial institutions, such as banks and credit unions, that build a business model around lending money. The borrower pays a price for taking out the loan in the form of interest. If the lender feels there’s a higher risk of not being paid back by a borrower, like with a new startup business, they will charge that borrower a higher interest rate. Lower-risk borrowers pay lower interest rates.

Lenders do not participate in your business in the same way as shareholders, owners, or partners. In other words, a lender has no ownership in your business. 

What are the different Types of Lending?

Lending can be broadly broken down into two categories: personal (or “consumer”) lending and business lending. Some types of loans are available in both personal and business lending, though they are handled differently.

For example, an individual can get a personal credit card to buy groceries and other basics, and a business can get a business credit card to buy equipment and other business expenses.

Differences Between Consumer Lending and Business Lending

From a borrower’s perspective, there are some legal protections with personal loans that aren’t extended to borrowers with business loans.

The Equal Credit Opportunity Act and the Fair Housing Act protects U.S. borrowers from discrimination. The general protections from discrimination extend to all forms of credit, whether it’s a personal loan or a business loan. However, the specific regulations of the Equal Credit Opportunity Act become more relaxed for business loans—the bigger the business entity, the fewer restrictions on their loans.

The restrictions that get relaxed have less to do with discrimination and more to do with what kind of notifications the lender must give the borrower, and how long the lender must retain certain records on the borrower.

The Fair Housing Act, on the other hand, doesn’t explicitly distinguish between consumer loans and business loans.

Business lending can help all different kinds of businesses. Some common uses for business loans include:

• Loans to even out cash flow (“working capital loans”)
• Commercial and industrial loans (which require collateral) for short-term needs
• Asset financing for equipment and machinery or business vehicles
• Mortgages
• Credit card financing
• Vendor financing (through trade credit) from suppliers

Other types of loans are for special purposes, like loans to finance disaster recovery or loans for business startup.

As you shop around for a business loan, consider these factors: 

• The amount of money you want to borrow, which will influence the type of lender that you need
• Any business assets you can pledge as collateral for the loan, which will help improve the terms of the loan
• What you want to do with the loan, which could affect the type of loan you seek (such as a mortgage for land or buildings)
• Whether you need a startup loan to start a business or an expansion loan to help grow an existing business 
• How long you need the money, which will affect the type of loan and lender that best fits your needs

What are some Types of Lenders?

The most common lenders are banks,​ credit unions, and other traditional financial institutions. However, there are many other types of lenders, including:

• Peer-to-peer (P2P) lenders
• Crowdfunding contributors
• Family and friends
• Yourself

P2P lenders can operate through online organizations, like LendingClub. These sites connect lenders with borrowers. P2P interest rates may be lower than borrowers would find with a traditional bank, but higher than a lender could receive from a certificate of deposit.

Crowdfunding sites like Kickstarter are similar to P2P lending sites, in that they digitally connect the people who need money with the people who have money. Unlike P2P lending, the people who contribute to crowdfunding efforts may not receive their money back dollar-for-dollar. Instead, they may receive perks from the person or project being funded. For example, someone may donate to a movie project’s Kickstarter, and in return, they’ll receive a copy of the movie once it’s completed.

Family and friends can become lenders, and these transactions are sometimes called “private party loans.” It’s important to consider the impact a loan might have on your personal relationship with these people. A loan agreement may help ensure everyone is on the same page.

If you have the means, you can loan your own money to your business, as an alternative to investing in it. If you choose to loan yourself money, write a contract that specifically spells out your role as a lender, the payment schedule, and the consequences for defaulting on payments.

Small business owners might also consider contacting the Small Business Administration (SBA). The SBA works with lenders to provide guarantees for loans to small businesses. Their 7(a) loan program helps small businesses get loans who might not otherwise qualify because of “weaknesses” in their applications.

The SBA doesn’t act as a lender. Instead, a lender makes the loan and the SBA will guarantee the loan by agreeing to repay up to 85% of the loss in case of default.4 The SBA’s 7(a) Small Loan, for example, allows you to borrow up to $350,000 with up to 75% of that $350,000 guaranteed by the SBA.

What is a Loan from a Bank?

A bank loan is when a bank offers to lend money to consumers for a certain time period. As a condition of the bank loan, the borrower will need to pay a certain amount of interest per month, or per year.

Secured Bank Loan. This is a loan which uses an asset as collateral. A good example is a mortgage loan. For this type of large loan, the Bank secures the house as collateral. If people, defer on their loan, the bank is able to legally possess the home to pay off the outstanding debt.

Unsecured Bank loan. This is a loan given without any asset for collateral. These tend to be for smaller amounts and typically attract a higher interest rate because of the perceived risk.

Inter Bank Loan. Often commercial banks are short of money and so are forced to borrow money on the money markets. These are typically short term loans and can be interbank or direct to the Central Bank.

Bank Loan Interest rates

Bank interest rates are influenced by the Central Bank’s base rate. This base rate, is the rate at which commercial banks have to borrow from the Central Bank. Because this rate is so important to the banking system, if the base rate goes up, commercial banks will invariably increase their saving and borrowing rates to consumers.

However, there are other factors. In a credit crunch it can be difficult to attract sufficient funds and therefore, interbank lending is more expensive and difficult. Therefore loan rates can rise, even if base rates stay the same.

Bad Credit Loan interest rates. For those customers with bad credit (often called subprime) banks will charge higher rates. During a credit crunch or adverse financial situation, people with bad credits may find it difficult to get any loans at all.

What is the Difference Between Lending and Borrowing?

Lending refers to the process when an entity or individual person gives away its recourses to another entity or individual persons as per predefined mutual terms then whereas Borrowing refers to the process of receiving of resources by an entity or individual person from another entity or individual person with predefined mutually agreed upon terms.

Example of Lending and Borrowing

A company, ABC Limited is involved in the development of infrastructure projects. They need funding to the extent of $100 million to complete their upcoming project for developing a road. They approached a Bank (XYZ Limited) to avail funding to the extent of $100 million for the said project and received funding from the Bank on mutually agreed commercial terms.

In the above example, XYZ Limited is lending money to ABC Limited. This process is known as lending and the XYZ Limited in this example is the lender. Similarly, ABC Limited in the example receives funds from XYZ Limited to complete the road project. This process is known as borrowing and ABC Limited is known as Borrower.

Key Differences

The key differences are as follows –

• A process when an entity or individual person gives away its recourses to another entity or individual persons as per predefined mutual terms then it is known as Lending whereas the process of receiving of resources by an entity or individual person from another entity or individual person with predefined mutually agreed upon terms is known as borrowing.
• Both are part of single transactions with different purpose of parties involved in the transaction
• Lending is the process of giving money to an entity/person however Borrowing is a process of receiving money from an entity/person
• In borrowing, resources are borrowed by a resource deficit entity from resource surplus entity. However, in lending resources are lent to a resource deficit entity by a resource surplus entity
• The lending entity in the transaction receives interest against the moneylender to the borrower. However, borrowing entity pays interest to lend an entity against the money borrowed by the borrowing entity
• Both are very critical to the economy of any country and operate with different purpose/business model. Lending the entity’s purpose is to earn interest on the money lend to borrowing entities. However, the borrowing entities borrow money for the purpose of their business expansion or individual borrow money to meet their goals such as house construction, children’s education, etc.
• Both are executed on either commercial or non-commercial terms based on the nature of the transaction. However, most of the time the terms of transactions are dictated by lending entities and borrowers have a relatively lesser say in this.
• Regulatory compliances for lending entities are much stricter than the borrowing entities.

Comparative Table

Basis		Lending		Borrowing
Definition		Lending is the process of giving money by a resource surplus entity/person to resource deficit person/entity on commercial terms or non-commercial terms based on mutual understanding.		Borrowing is a process of taking/receiving money by a resource deficit entity/person from resource surplus person/entity on commercial terms or non-commercial terms based on mutual understanding.
Purpose		Generally, the purpose of lending is to earn interest on the money lent to borrowing entity. The business model of most of the lending entities such as Banks and Financial Institutions is to earn interest by lending money to entities in need.		The purpose of the borrowing entities to deploy the borrowed money or resources in the day to day operation of the Company or to set up a new project or to expand the business etc.
Money/Resource  Flow in Transaction		From a resource surplus entity to resource deficit entity.		From a resource surplus entity to a resource deficit entity.
Parties Involved		Both are part of the transaction.		Both are part of the transaction.
Nature of Business		A Lending entity’s primary nature of the business is generally lending money to entities looking to expand or set up businesses. A major example of lending entities in the real world are Banks and Financial Institutions		A Borrowing entity may be involved in various businesses wherein they need resources/money to operate or to set up new businesses. A major example of borrowing entities is large business houses operating in sectors such as real estate, steel, power, energy, roads, etc.
Risk Exposure		Lending entities in these transactions are generally at higher risk because of risk associated with borrowing entities defaulting on returning the money to the lending entity.		Borrowing entities are relatively at lower risk in comparison to lending entities as they are receiving money from the lending entity for their businesses.
Terms of Transaction		Terms of the transaction are decided based on a mutually agreed basis but mostly dictated by the lending entities.		The terms of the transaction are decided based on a mutually agreed basis. In the case of a borrower with string financials, terms of borrowing are dictated by borrowing entities.
Interest Payment		Lending entities receive interest payments against the money lent to borrowing entity based on mutually agreed terms.		Borrowing entities pay interest against the money borrowed based on mutually agreed terms.
Example		A Bank named ABC Limited, lending $100 million to an entity XYZ Limited to set up a road project on commercial terms is an example of the lending process. ABC Limited in this process is the lender.		In the same example, the entity XYZ Limited is borrowing $100 million to use that money for setting up the road project. This process is known as borrowing and the entity XYZ Limited is known as a borrower.

Lending and borrowing are both parts of a single transaction wherein one party is a lender and the other is the borrower. Both are required for a lending or borrowing transaction to be completed. They basically involve resource transfer from resource surplus entity to resource deficit entity on mutually agreed terms. A lending entity generally gets paid interest on the money lent to borrowing entity.

Both are very critical for any economy to grow as these help in the effective utilization and transfer of resources in a systematic manner within the economy.

How can I get Approved for a Loan?

There’s no universal formula for winning approval of a personal loan application. Requirements such as credit score and income vary by lender, and some online lenders consider nontraditional data, like free cash flow or education level.

But loan companies have one thing in common: They want to get paid back on time, which means they approve only borrowers who meet their requirements. Here are five tips to boost your chances of qualifying for a personal loan.

1. Clean up your credit

Credit scores are major considerations on personal loan applications. The higher your score, the better your approval chances.

Check your reports for errors. Common errors that may hurt your score include wrong accounts, closed accounts reported as open and incorrect credit limits, according to the Consumer Financial Protection Bureau.

You can get your credit reports for free once a year at AnnualCreditReport.com. With evidence to support your claim, dispute any errors online, in writing or by phone.

Get on top of payments. If you’re not already, be vigilant about making monthly payments toward all your debts, paying more than the minimums when you can. This will benefit your payment history and credit utilization ratio, which is the percentage of your available credit that you’re using. Together, these two factors make up 65% of your FICO score.

Request a credit limit increase. Call the customer service numbers on the back of your credit cards and ask for an increase. You have a better chance if your income has risen since you acquired the card and if you haven’t missed any payments.

This strategy can backfire and temporarily hurt your credit score if it requires a hard pull on your credit, so ask the creditor beforehand, says Justin Pritchard, a certified financial planner based in Montrose, Colorado.

2. Rebalance your debts and income

Loan applications ask for your annual income, and you can include money earned from part-time work. Consider starting a side hustle to supplement your income, or work toward a raise at your full-time job.

Also, do what you can to pay down debt.

Consider selling liquid assets such as stocks held in taxable accounts. Using the proceeds toward high-interest consumer debts should get you a higher rate of return, says Alison Norris, advice strategist and certified financial planner at personal finance company SoFi.

Boosting your income and lowering your debt improves your debt-to-income ratio, which is the percentage of your monthly debt payments divided by monthly income. Not all lenders have strict DTI requirements, but a lower ratio shows that your current debt is under control and you can take on more.

3. Don’t ask for too much cash

Requesting more money than what you need to reach your financial goal can be seen as risky by lenders, says Norris.

“Look at the reason why you’re asking for the loan, tie a specific dollar amount to that financial need, and only ask for that amount,” she says.

A larger personal loan also squeezes your budget, as higher loan payments impact your ability to meet other financial obligations, such as student loans or mortgage payments.

4. Consider a co-signer

If your credit scores are in the “fair” range, adding a co-signer with stronger credit and income can increase your chances of approval.

Read Also: Maximum FHA Loan Amount

Because the co-signer is equally responsible for repaying the loan, it’s critical to co-sign with someone who can afford the risk, Pritchard says.

“You may have every intention of repaying the loan, but you can’t predict a job loss, disability or other event that impacts your income and ability to repay the loan,” he says.

Have an honest conversation with the prospective co-signer so they fully understand the risks before agreeing.

5. Find the right lender

Most online lenders disclose their minimum requirements for credit scores and annual income and whether they offer options like co-signers.

If you meet a lender’s minimum qualifications and want to see estimated rates and terms, you can pre-qualify for financing. With most lenders, pre-qualifying triggers a soft credit pull, which has no impact on your credit score.

Pre-qualify with multiple lenders and compare rates and terms. The best loan option has costs and payments that fit into your budget.