You may not be familiar with the term “consumer loan,” but the odds are high that you’ve taken out one of these loans in the past. Consumer loans are a category of lending products designed to help you finance a wide range of consumer purchases, from day-to-day shopping needs to major life events such as buying a home.
The vast majority of loan products available to you fall under the umbrella of consumer loans. For this reason, it’s important to understand how consumer loans work, how they can be used, and the benefits they can offer as a financial tool—as long as you don’t abuse the privilege of these products.
5 Common Types of Consumer Loans
When used responsibly, a wide range of consumer loans can help you reach financial goals and develop excellent money management skills. Here are the most common types of consumer loans you might seek out at some point in your life:
- Mortgage loans: These are used to finance a home or even access equity you’ve built up in a property you already own.
- Auto loans: According to Experian data provided by U.S. Public Interest Research Group in 2018, 85 percent of new car purchases and more than half of used car purchases involve auto financing.
- Credit cards: Rolling credit accounts fall under the consumer loan category. Excessive spending on credit cards can put consumers in a deep financial hole, but responsible use of credit cards can improve cash flow management and even generate rewards.
- Personal loans: Personal loans can be broad and flexible, allowing you to afford a wide range of purchases.
- Student loans: Educational loans fall under the umbrella of consumer loans.
The Benefits of Taking Out Consumer Loans
Some financial experts recommend caution when taking out consumer loans because certain types of these loans are more supportive of consumer spending than building long-term wealth. However, a consumer loan can offer a number of benefits, depending on your goals and your short-term financial needs. These benefits include:
- The ability to spread out spending over time: When large purchases are unfeasible or would cut too deep into your cash reserves, loans let you afford those purchases and build repayment into your monthly budget.
- Purchasing power to afford a home and other financial goals: Major purchases often aren’t possible without access to consumer loans.
- The potential to build your wealth, depending on the purpose of the loan: Mortgages, for example, allow you to build equity in a property. Student loans may also increase your lifetime earning potential.
- Financial stability in the form of maintaining short-term liquidity: By leaning on consumer loans to finance large purchases, you can maintain an emergency fund and cash reserves for other spending needs.
Do You Need a Closed or Open-Ended Consumer Loan?
Consumer loans are structured in one of two key ways: either as a fixed loan that is repaid over a set period of time or as a revolving credit account that you can use at your own discretion.
Closed loans are structured with a fixed interest rate, monthly payment amount, and repayment term. Most of your loans likely fall under this category, including mortgages, auto loans, and student loans.
Open-ended loans are more flexible to your borrowing and repayment needs. This can include credit card accounts and home equity lines of credit, among other open-ended options.
How to Compare Consumer Loan Options
Before you accept a consumer loan offer, it’s important to review the terms of the loan to make sure it meets your needs and is competitive with the current lending market. Key criteria to evaluate include:
- Interest rate: Higher interest rates result in higher monthly payments.
- Repayment term: The length of your repayment term dictates the size of your monthly payment.
- Fees (including annual fees for revolving accounts): Different lenders will charge different amounts of fees.
- Collateral requirements, if any: Depending on your credit and other lending factors, you may need to provide collateral for your loan.
- Early repayment fees. Some loans may charge you an additional fee if you decide to pay off the debt ahead of schedule.
By using consumer loans responsibly and managing debt as a financial tool, you can improve financial stability, optimize your cash flow, and leverage consumer loan debt to increase your net worth over time.
Discover more strategies for building long-term financial stability—download our Financial Planning During Uncertain Times guide today.