Which Type of Loan Is Right for You?

Before signing, consider the advantages of a loan based on your own financial situation.

woman applying for loan from couch
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Whether you're looking to refinance your car or managing loans to pay off student debt, how can you decide which loan is the right one for you and your financial situation? Trying to figure out how to tackle the ins and outs of loans can be a hard thing to do. Before signing, be aware of the loan repayment terms. Knowing these details will ensure you'll be able to pay off the loan on time as well as position yourself for financial investments in the future. Here, we spoke with Colleen McCreary, chief people officer at Credit Karma, on the topic of shopping for loans.

Different Types of Loans, Explained

To help you get started, review the variety of loans available and their advantages: payday loans, title loans, home-equity loans, as well as personal loans (both secured and unsecured). Personal loans are among the most versatile types of loans, however, individual lenders may put restrictions on the use for these loans. Auto loans and mortgage loans allow borrowers to pay for these major purchases over time, albeit, with the risk of repossession. Home-equity loans have low interest rates, but the borrower's home serves as collateral. Student loans also have a longterm payoff timeline, but can be granted "forgiveness" altogether after a career in public service. Payday loans do not require collateral but come with high interest rates that oftentimes deems them predatory. Consider how you plan to use the money and, if you're still unsure of the best option, consult a financial advisor for their advice.

McCreary leaves it at this: "The key is to shop around and compare multiple offers before choosing the loan that best fits your unique financial situation. A bit of research can help you find the best rates and terms."

Credit Score

It's worth noting that the process of loan applying involves your credit report. This can be a good thing if you can pay your loans on time as it will only strengthen your credit score. On the other hand, this could have a negative effect on your credit score if you're late on your payments. McCreary explains the concept of hard inquiry when applying for a loan: "When you apply for a loan, the lender will likely pull your credit as part of the application process. This is known as a hard inquiry and will usually temporarily lower your credit scores by a few points. If you're worried about the impact on your credit score, consider checking your rates with lenders that will do soft pulls, which won't impact your scores."

Interest Rates and Fees

The last factor to consider when loan shopping is interest rates and fees. These vary by the type of loan, the length of the loan, as well as the lender. Have a clear understanding of interest rates, which are informed by your credit score: The better your score, the lower the interest rate as well as the longer the duration of your loan.

Prepayment penalties also factor into how much you'll pay in the end. While it may seem like a good idea to pay your loan off early, some lenders will charge you a prepayment penalty to make up for the interest they missed. "You don't want to put yourself in a situation where you can't pay back the loan on time and in full. Even if you lower your interest rate, there's a chance your loan could cost you more if you stretch out your repayment period for too long," says McCreary. "For instance, if you use a personal loan with a five-year repayment term when you'd otherwise have repaid the debt in two years, you'll pay interest for three years longer."

Having a loan payback plan in place before signing is key when loan shopping. McCreary urges loan seekers, "You don't want to find yourself in a situation where you're accruing unnecessary debt through fees and interest."

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