If you’re looking to use a personal loan to get out of financial trouble or to consolidate debt, you’re not alone. According to a study by Bankrate, the average consumer in 2020 took out a personal loan of about $16,458. Before taking the loan you need, you should compare the types of loans available.
What is a personal loan?
A personal loan is a loan product available through a bank, credit union or online lender. It is commonly used to cover financial emergencies, home improvements, or debt consolidation. Most personal loans are disbursed as a lump sum and are repaid in installments over a period of time, usually between one and seven years.
Expect to pay 4 to 36 percent interest depending on your creditworthiness and the loan product you choose.
Types of personal loans
There are an assortment of personal loan options to choose from and you can get a variable or fixed interest rate.
Secured Personal Loans
A secured personal loan requires you to keep assets that act as collateral. For example, you can take out a loan against your vehicle, known as a title loan.
This can be an ideal option if you have a low credit score and property to put up as collateral, but there is a downside. If you fall behind on loan payments, the lender can seize your property and sell it to repay their debt.
Unsecured personal loan
These loan products do not require collateral to be approved. Plus, you get faster access to funds without risking your assets.
Unsecured personal loans are best for borrowers with good or excellent credit. However, you will pay more interest than a secured personal loan because the lender assumes more risk.
Debt Consolidation Loans
Debt consolidation loans are typically used to pay off outstanding debt balances faster while saving on interest. Borrowers also get the benefit of streamlining the repayment process.
The idea is to secure a loan with a lower interest rate than you currently pay on the debt you plan to consolidate. You’ll use the loan proceeds to pay off that balance and make payments on a new loan product over a fixed period of time. Ideally, you’ll save hundreds or thousands of dollars in interest and get out of debt faster.
Debt consolidation loans can be risky if you’re using a credit card to pay off balances and don’t hesitate to swipe the card once you’ve cleared the balance. You may end up borrowing more than you started with.
Co-signed and joint loans
If you can’t qualify for a personal loan yourself, a lender can approve you with a co-signer. This person should have a strong credit history and be willing to assume responsibility for the remaining balance if you miss loan payments. However, the co-signer will not have access to the loan amount.
Some lenders also offer joint loans, which allow both borrowers to access the funds. As with co-signed loans, both parties will be responsible for loan payments. Your co-borrower will require good or excellent credit to strengthen your chances of getting approved for a loan.
fixed rate loan
Fixed-rate loans come with an interest rate that does not change over the repayment term. As a result, the borrower makes equal monthly payments for the duration of the loan term.
Most personal loans fit into this category. It’s easy to work debt payments into your spending plan because it won’t change over time.
Variable-rate loans come with a fluctuating interest rate. As time passes, your monthly payment may go up or down if the benchmark rate established by banks changes.
While budgeting for payments on a variable-rate loan can be challenging, the rates are sometimes lower than what you’d get with a fixed-rate loan. Therefore, you should consider this type of personal loan only if you want to borrow funds for a short period only.
Personal credit line
A personal line of credit works like a line of credit, and gives you access to a pool of funds that you can borrow anytime you need funds. Unlike a personal loan, which requires you to pay interest on the total loan amount, you only pay interest on the amount you withdraw.
This loan product is suitable for borrowers who want a safety net that can be used as and when required.
Buy now, pay off debt later
Buy now, pay later loans allow customers to purchase without paying the total purchase price upfront. Instead, the balance is split and payable in equal installments, weekly or bi-weekly.
These loans are usually extended by mobile apps like Afterpay, Klarna and Affirm. You can get approved for a buy now, pay off later loan with perfect credit if you demonstrate your ability to repay the loan. Most lenders will review your bank activity and may perform a soft credit check, which will not affect your credit score.
Types of personal loans should be avoided
Some personal loans can be bad news for your finances and should only be used as a last resort. Here are some options to avoid:
- Cash-advance credit cards : Some credit card issuers allow cardholders to take cash advances from their available credit at an ATM or bank. But this benefit comes at a big cost – you’ll be assessed cash advance fees and higher interest rates on the amount you borrow.
- Cash Advance Ups : These ups give you quick access to cash, usually up to $250, by payday. Most charge a monthly fee to use this service, and you have to pay back what you borrow on your next payday or in a two-week period.
- Payday Loans : These loans are an expensive type of loan that caters to borrowers with bad credit. Payday loans usually come with high interest rates and are due on payday. If you can’t repay the loan and extend the loan term, they often create a dangerous debt cycle.
- Pawnshop Loans : If your local pawn shop offers loans, you can hand over your property in exchange for cash. You’ll probably pay a lot of interest, and the pawn shop will keep your property if you default on the loan.
How to choose the best type of personal loan for you
Ultimately, you want a loan product from a reputable lender that offers competitive interest rates and monthly payments you can afford. It is equally important to consider the most suitable options based on your creditworthiness, financial situation and intended use.
A personal loan may be suitable if you need a fixed amount to make a specific purchase. But if you want the flexibility to borrow funds when you need them, a line of credit may be more ideal.
Use the Bankrate Personal Loan Marketplace to explore your options and find a loan that fits your lending needs.