There are many different types of loans, each with its own terms, interest rates, and payback periods. Please note that interest rates are only one way to compare loans. There are other variables to consider including:
- The duration of the payback period.
- General terms and conditions.
- Who is providing the loan.
In general, if you are looking to get a loan for education or for your own day to day activities, you can choose between the following:
- Payday Loan – Highest rates
- Private Loan – High rates
- Personal Loans – Medium rates
- Federal Student Loan – Lowest rates
Generally speaking, federal student loans have the lowest interest rates. Why? Because the government has a strong incentive for you – and all others – to get educated.
Federal student loan rates as of early 2021 have an interest rate of 4.5%. A personal loan can range from an interest rate between 5% and 17% depending on one’s credit score and the size of the loan.
Payday loans are usually the most expensive to acquire.
Types of Loans
Before securing a loan, you first need to figure out why you are borrowing money, how long you will need to repay the loan, and what you are borrowing against.
For example, a home loan (called a mortgage) usually offers the lowest interest rates. Why? Because if you fail to make the loan payment the lender (in this case the bank) and secure the home. This type of loan reduces risk because the loan is backed by a tangible asset.
Now consider a personal loan.
Maybe you have good credit, or maybe you do not. Maybe you have a strong and reliable income, or perhaps you are changing jobs. These variables impact your credit worthiness and therefore your risk profile. The riskier your profile the higher the interest rate. This is because the person providing the loan will want to get compensated for the risk of you not paying the loan back.
This protection is taken in the form of a higher interest rate.
Student loans, in contrast, have more palatable rates because the government can pool default risks across millions of students. Likewise, the government subsidies these loans with lower interest rates because the government has an interest in young people advancing their earning power through education.