What Is a Consumer Loan?

If a bank loans money to a business, that's called a commercial loan. A consumer loan is where a banks and other lender extends credit to individuals for personal or household purposes. Since consumers are presumed to have less knowledge and bargaining power than businesses, the consumer loan industry is highly regulated. All consumer loans must comply with consumer protection law such as the Truth in Lending Act of 1968, as implemented by Regulation Z, which requires clarity of key terms in credit agreements and disclosure of all costs.

This is the popular type of loan that enables borrowers to acquire an item such as a house, an automobile or an appliance and pay for it over a period of months or years. Installment loans are repaid at regular intervals, usually monthly, and each payment includes a portion of the principal amount and some interest. While the loan is being repaid, the lender retains a "security interest" or ownership in the item being financed.

One of the most commonly understood types of consumer loan is the term loan. These are used in situations where a borrower needs cash for a specific period of time such as 90 days or one year. The bank will give the borrower a single payment which he can use for whatever purpose he wishes, such as buying a car or paying off credit card debt. Term loans or time loans are must be repaid in full, including interest, on the maturity date of the promissory note.

Another type of consumer loan is the line of credit. This is not a loan as such but a pool of cash, with a maximum limit, that the consumer can dip into whenever she needs some money. She can draw cash advances as needed and repay the advances from income and repay principal at a time of her choice. A credit card is a good example of a line of credit. You borrow on the card up to your maximum permitted balance, and pay down the debt at periodic intervals. The credit card company will bill you for interest payments on the amount you have borrowed, not the maximum amount you are authorized to borrow, which is the main advantage of this type of loan.

A homeowner can use the equity in his house, that is, the difference between the amount he owes on his mortgage and the current value of his house, as security for another loan. He will execute a second mortgage for the home equity loan. The new loan can be for up to 80 percent of the available equity. A traditional use for such a loan is to finance some improvement to the home such as building a wing or a new garage.

Several types of student loans are available for financing the cost of higher education. Students may borrow from lenders directly, or parents may borrow and use the funds for their dependent children. Interest rates are lower than with normal loans because interest payments are partially subsidized by the federal government. Students can delay the start of their loan payments for six months after graduation or after they leave full-time enrollment.