If you want to use a personal loan to overcome a financial obstacle or consolidate debt, you are not alone. According to a Bankrate study, the average consumer had about $16,458 in personal loan debt in 2020. Before you go ahead with borrowing the funds you need, you should compare the types of loans available.
What is a personal loan?
A personal loan is a debt product available through a bank, credit union, or online lender. It is commonly used to cover a financial emergency, make home improvements, or consolidate debt. Most personal loans are disbursed as a lump sum and paid in installments over a set period, usually between one and seven years.
Expect to pay between 4 percent and 36 percent interest, depending on your creditworthiness and the loan product you select.
types of personal loans
There are a variety of personal loan options to choose from, and you’ll get a variable or fixed interest rate.
secured personal loans
Secured personal loans require you to present an asset to serve as collateral. For example, you could take out a loan against your vehicle, known as a title loan.
While this could be an ideal option if you have a lower credit score and an asset to pledge as collateral, there is a downside. If you fall behind on your loan payments, the lender may seize your asset and sell it to recover what is owed to you.
Unsecured personal loans
These loan products do not require collateral to be approved. Plus, you’ll get quick access to funds without putting your assets at risk.
Unsecured personal loans are best for borrowers with good or excellent credit. However, you will generally pay more interest than a secured personal loan, since the lender takes on more risk.
debt consolidation loans
Debt consolidation loans are commonly used to pay off outstanding debt balances faster by saving interest. Borrowers also get the benefit of simplifying the payment process.
The idea is to secure a loan with a lower interest rate than what you’re currently paying on the debts you plan to consolidate. You’ll use the loan proceeds to pay off those balances and make payments on a new loan product over a set period. Ideally, you’ll save hundreds or even thousands of dollars in interest and pay off debt faster.
A debt consolidation loan can be risky if you use it to pay off credit card balances and don’t refrain from swiping the cards once you’ve eliminated the balances. You could end up with more debt than you started with.
Co-signed and joint loans
If you can’t qualify for a personal loan on your own, the lender might approve you with a co-signer. This person must have a strong credit history and be willing to take responsibility for the remaining balance if you default on the loan. However, the co-signer will not have access to the loan proceeds.
Some lenders also offer joint loans, allowing both borrowers to access the funds. Like cosigned loans, both parties will be responsible for loan payments. Your co-borrower will need good or excellent credit to strengthen their chances of getting approved for a loan.
Fixed rate loans
Fixed-rate loans come with an interest rate that doesn’t change during the repayment term. Consequently, the borrower makes the same monthly payment over the term of the loan.
Most personal loans fall into this category. Working loan payments into your spending plan is easier since it won’t change over time.
Variable rate loans
Variable rate loans come with a fluctuating interest rate. As time goes by, your monthly payment could go up or down if the benchmark rate set by banks changes.
While it’s challenging to budget for payments on variable-rate loans, sometimes the rates are lower than what you’ll get with a fixed-rate loan. Therefore, you should only consider this type of personal loan if you only need to borrow funds for a short period.
personal line of credit
A personal line of credit works like credit, and you’ll have access to a pool of funds that you can borrow from anytime you need funds. Unlike personal loans, which require you to pay interest on the full amount of the loan, you will only pay interest on the amount you take out.
This loan product is suitable for borrowers who want a safety net that can be accessed as needed.
Buy now pay later loans
Buy now, pay later loans allow consumers to make a purchase without paying the full purchase price up front. Instead, the balance is divided and paid in equal installments, weekly or fortnightly.
These loans are usually made through mobile apps, such as Afterpay, Klarna, and Affirm. You could be approved to buy now, pay back a loan later with less than perfect credit if you demonstrate your ability to repay the loan. Most lenders will review your banking activity and may run a soft credit check, which will not affect your credit score.
Types of personal loans to avoid
Some personal loans can spell bad news for your finances and should only be used as a last resort. Here are some options to avoid:
- Cash Advance Credit CardNote: Some credit card issuers allow cardholders to get a cash advance on their available credit at an ATM or bank. But this benefit comes at a high cost: You’ll likely be charged a cash advance fee and a higher interest rate on the amount you borrow.
- cash advance apps: These apps also allow you to access fast cash, usually up to $250, until payday. Most charge a monthly fee to use this service, and you’ll have to pay back what you borrowed on your next payday or within two weeks.
- payday loans: These loans are an expensive form of debt that cater to borrowers with bad credit. Payday loans generally come with high interest rates and are paid on payday. They often create a dangerous cycle of debt if you can’t pay and extend the term of the loan.
- Pawn Shop Loans: If your local pawn shop offers loans, you can trade your asset for cash. You will likely pay an exorbitant amount of interest, and the pawnbroker will take 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 trusted lender that offers a competitive interest rate and monthly payments you can afford. It is equally important to consider the most appropriate options based on your creditworthiness, financial situation and intended use.
A personal loan could be a good option 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 Bankrate’s Personal Loan Marketplace to explore your options and find a loan that meets your borrowing needs.