8 Types of personal loans and their uses — plus 5 to avoid
Key takeaways
- Personal loans come in many forms, including secured and unsecured loans, debt consolidation loans and personal lines of credit.
- Unsecured personal loans are common among lenders and don’t require collateral.
- Secured personal loans are less common and require collateral — but usually offer lower interest rates.
- You can use personal loans for a variety of purposes, such as consolidating credit card debt, paying off the cost of a medical procedure or financing a home improvement project.
You’re not alone if you’re considering a personal loan to get over a financial setback or consolidate debt. According to an Experian study, the average consumer has personal loan debt of around $19,402. However, depending on your credit and financial situation, some personal loans work better than others.
8 Types of personal loans
Personal loans offer versatility, catering to individuals across a spectrum of credit profiles. All personal loans are installment loans, meaning you borrow a lump sum and repay it in fixed monthly installments. These payments can be easier to budget for than a credit card’s varying payments. Less commonly, there are also variable rate personal loans, where monthly installments are subject to change.
Know your credit score before applying. This will help you decide whether you should get an unsecured or secured personal loan and whether to consider a joint or cosigned loan. Knowing the loan type you need will also help you determine where to start your search. Different personal loans are available from different banks, credit unions and online lenders.
Unsecured personal loans
An unsecured personal loan, sometimes called a signature loan, doesn’t require collateral to get approved. Qualifying is based on your credit score, income and outstanding debt load. You’ll typically need good or excellent credit to get approved for the best rates. Some lenders also consider your employment and education history.
If you default on an unsecured personal loan, you won’t risk losing an asset. You will, however, damage your credit. You may also face high fees and legal proceedings if you can’t repay.
Those with excellent credit and a low debt-to-income (DTI) ratio.
Secured personal loans
Like auto loans and mortgages, secured personal loans require collateral for approval. Rather than being backed by a car or house, a secured personal loan might rely on something like a certificate of deposit (CD) or a savings account.
Because the loan is secured, the lender takes on less risk and may offer lower interest rates than you would get with an unsecured personal loan. The tradeoff is that if you default, you risk losing the asset you put up as collateral. This is because the lender can legally seize it to offset what you owe.
Borrowers who have less-than-ideal credit and are certain they can repay the loan.
Debt consolidation loans
Debt consolidation loans combine multiple loans into a single payment, potentially allowing borrowers to pay off outstanding balances faster and save on interest. The idea is to borrow a loan with a lower interest rate than what you currently pay on the debts — credit card, medical and other bills — you plan to consolidate.
Your new loan may come with fees, such as an origination fee, that could cut into your savings. Make sure you have a plan to manage your loan so you don’t end up in deeper debt.
Those with multiple streams of high-interest debt.
Cosigned and joint loans
If you’re unable to qualify for a personal loan on your own, a lender might approve you with a creditworthy cosigner.
Your cosigner must be willing to assume equal responsibility for the loan without being able to access the funds. They must also be able to support the cost of the loan on their income alone.
If you default on the loan payments and your cosigner fails to cover the payments, their credit score will decrease along with yours.
Some lenders also offer joint loans, which allow both borrowers to access the loan funds. Like cosigned loans, both parties will be liable for loan payments. Your co-borrower will need good or excellent credit to strengthen your chances of getting approved for a loan.
Borrowers with a lower credit score who have a creditworthy cosigner on hand or those who want to share access to the loan funds.
Fixed-rate vs. variable-rate loans
The vast majority of loans have a fixed rate, meaning the interest doesn’t change over the repayment term. You make the same monthly payment every time. This is good for credit borrowers who qualify for a competitive interest rate and prefer payment stability.
In contrast, variable-rate loans are loans with an interest rate that fluctuates with the market. You may be able to secure a lower annual percentage rate (APR) with a variable loan but you also risk having your rate increase. This makes budgeting for variable-rate loans more challenging because they change over time. This type of loan is better for individuals seeking an inexpensive, short-term loan who can also aggressively pay off the loan before it could increase in rate.
Fixed rates are good for credit borrowers who prefer payment stability and qualify for a competitive interest rate. Variable rates are good for individuals seeking an inexpensive, short-term loan.
Personal line of credit
A personal line of credit gives you access to a pool of funds that you can borrow from when you need to — similar to a credit card. You’ll only pay interest on the amount you borrow. However, a downside to keep in mind is that, unlike credit cards, personal lines of credit don’t have an interest-free grace period.
This may be a good option for people who want flexible access to funds but want a better rate than a credit card. A line of credit may be helpful for a kitchen or bathroom renovation, overdraft protection or an ongoing emergency.
Personal lines of credit typically have variable rates and can be secured by a banking asset, but you may be able to find unsecured options with online lenders or smaller banks.
Those undertaking a longer, expensive purchase or project.
Buy now, pay later loans
Buy now, pay later loans allow you to make a purchase without paying the total purchase price upfront. Instead, the balance is divided and payable in equal installments, typically due in full within six weeks of the purchase date.
These loans are often offered through mobile apps, like Afterpay, Klarna and Affirm. Most lenders will review your bank activity and may conduct a soft credit check, which won’t impact your credit score. You could get approved for a buy now, pay later loan with less-than-perfect credit if you have the income to support the payments.
On-time payments on BNPL loans are not typically reported to the credit bureaus, though late payments may be. That means this type of funding is more likely to harm your credit score than help it. Beware the temptation to overspend or take out more BNPL loans than you can juggle.
Borrowers who need immediate access to financing on a per-purchase basis.
5 Types of loans to use sparingly
Some personal loans have extraordinarily high interest rates and should only be used as a last resort. For borrowers with bad credit or no access to a bank account, they may be one of a limited set of options.
If you can avoid them, you should. But if you can’t, be sure to stay on top of payments and try to pay off the loan as quickly as possible.
- Credit card cash advances: Some credit card issuers allow you to take a cash advance from your available credit at an ATM or bank. This perk comes at a hefty cost. You’ll likely be assessed a cash advance fee and a higher interest rate on the amount you borrow.
- Cash advance apps: These apps also let you access fast cash, usually up to $250 or $500, until payday. Most lenders charge a monthly fee to use their service, and you’ll have to repay what you borrow on your next payday or within a two-week period. Read the fine print, because some have fees equivalent to an APR as high as 300 percent.
- Payday loans: These loans are a costly form of debt that cater to borrowers with poor credit. Payday loans typically come with steep fees and interest rates well over 300 percent. They can lead to a dangerous debt cycle if you can’t repay and end up having to extend the loan term.
- Pawnshop loans: If your local pawnshop offers loans, you can exchange your asset for cash. You’ll likely pay a huge amount of interest, and the pawnshop will keep your property if you default.
- Title loans: A car title loan uses your vehicle’s title as collateral. You borrow against the value of your car, which means lower interest rates than unsecured options. But you risk high fees — or even losing your car — if you miss any payments.
Bottom line
When it comes to personal loans, the landscape is rich with options tailored to meet a diverse range of needs. From unsecured loans with no collateral requirements to secured loans backed by assets, each has its own set of benefits and drawbacks.
Before applying, understand how personal loans work and what to expect. Familiarize yourself with the terms, interest rates, repayment structures and potential fees associated with each loan type. By gaining a comprehensive understanding of personal loans, you can navigate the borrowing process with confidence.
Frequently asked questions
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