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A loan is a sum of money that you borrow from a financial institution — a bank, credit union or online lender — or a person, like a family member, and pay back in full at a later date, typically with interest.
All loans have similar attributes. There are different types of loans, depending on what you use them for.
» MORE: Compare the best personal loans
How do loans work?
Loans generally have four primary features: principal, interest, installment payment and term. Understanding each of these will help you decide if a loan is suitable for your purpose and how affordable it is.
Principal: This is the amount of money you borrow from a lender. It may be $500,000 for a new house or $500 for a car repair.
Interest: The interest rate is the cost of a loan — how much you have to pay back in addition to the principal. Lenders determine your interest rate based on several factors, including your credit score, the type of loan and how much time you need to repay the loan.
Interest is different from the annual percentage rate, or APR, which includes other costs like upfront fees.
Installment payments: Loans are usually repaid at a regular cadence, typically monthly, to the lender. Your monthly payment is commonly a fixed amount.
Term: The loan term is how much time you have to repay the loan in full. Depending on the type of loan, the term can range from a few weeks to several years.
Types of loans
Loans fall into two broad categories: secured loans and unsecured loans.
Examples: A mortgage or an auto loan.
For secured loans, the lender typically uses a physical asset, like your home or car, to secure its money if you cannot repay the loan as agreed. The lender bases your interest rate on the asset as well as your credit score and credit history. Secured loans typically have lower interest rates than unsecured loans.
Examples: A student loan for education, a personal loan or a payday loan.
Lenders offering unsecured loans base your interest rate on your credit score, credit history, income and existing debt. If you don't pay back the loan as agreed, the lender can't seize any of your assets, but it can report the default to the credit bureaus, which will hurt your credit score and your ability to get another loan in the future.
Unsecured loans typically come with higher interest rates and smaller loan amounts than secured loans.
Here’s a snapshot of different types of loans, as well as their terms and interest rates.