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A personal loan is a debt product available through a bank, credit union or online lender. It’s either secured or unsecured and can be used for various reasons. The loan proceeds are disbursed as a lump sum and payable in installments over a set period, generally between one and seven years.
You’re not alone if you’re considering a personal loan to get over a financial hump or consolidate debt. According to a Bankrate study, the average consumer carried personal loan debt of around $17,064 in 2021. Before you move forward with borrowing the funds you need, you should compare the types of loans that are available.
Types of personal loans
There is an assortment 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 put up an asset as collateral. For example, you could take a loan out 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 put up as collateral, there’s a downside. If you fall behind on the loan payments, the lender could seize your asset and sell it to recoup what they’re owed.
Unsecured personal loans
These loan products do not require collateral to get approved. Plus, you’ll get fast access to funds without putting your assets at risk.
Unsecured personal loans are best for borrowers with good or excellent credit. However, you’ll generally pay more interest than a secured personal loan since the lender assumes more risk.
Debt consolidation loans
Debt consolidation loans are commonly used to pay off outstanding debt balances faster by 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 what you currently pay on the debts you plan to consolidate. You’ll use the loan proceeds to eliminate those balances and make payments on a new loan product for a set period. Ideally, you’ll save hundreds or even thousands of dollars in interest and get out of debt faster.
A debt consolidation loan can be risky if you use it to pay off credit card balances and you don’t refrain from swiping the cards once you’ve axed the balances. You could end up with more debt than you started with.
Co-signed and joint loans
If you’re unable to qualify for a personal loan on your own, the lender might approve you with a co-signer. This individual should have a strong credit history and be willing to assume responsibility for the remaining balance if you default on the loan payments. However, the co-signer won’t have access to the loan proceeds.
Some lenders also offer joint loans, which allows both borrowers to access the funds. Like co-signed 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.
Fixed-rate loans come with an interest rate that doesn’t change over the repayment term. Consequently, the borrower makes the same monthly payment for the duration of the loan term.
Most personal loans fit into this category. Working the loan payments into your spending plan is easier since it won’t change over time.
Variable-rate loans come with a fluctuating interest rate. As time passes, your monthly payment could go up or down if the benchmark rate established by banks changes.
While it’s challenging to budget for payments on variable-rate loans, rates are sometimes lower than what you’ll get with a fixed-rate loan. So, 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 operates like a credit, and you’ll get access to a pool of funds that you can borrow from any time you need funds. Unlike personal loans, which require you to pay interest on the total loan amount, you’ll only pay interest on the amount you draw.
This loan product is suitable for borrowers who want a safety net that can be tapped into on an as-needed basis.
Buy now, pay later loans
Buy now, pay later loans allow consumers to make a purchase without paying the total purchase price upfront. Instead, the balance is divided and payable in equal installments, weekly or biweekly.
These loans are typically extended through mobile apps, like Afterpay, Klarna and Affirm. You could get approved for a buy now, pay later loan with less than perfect credit if you demonstrate your ability to repay the loan. Most lenders will review your bank activity and may conduct a soft credit check, which won’t impact your credit score.
Types of loans to avoid
Some personal loans could mean bad news for your finances and should only be used as a last resort. Here are some options to avoid:
- Cash-advance credit card: Some credit card issuers allow cardholders to take a cash advance from their available credit at an ATM or bank. But 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, until payday. Most charge a monthly fee to use this service, and you’ll have to repay what you borrow on your next payday or within a two-week period.
- Payday loans: These loans are a costly form of debt that cater to borrowers with poor credit. Payday loans typically come with steep interest rates and are payable on payday. They often create a dangerous debt cycle if you can’t repay and extend the loan term.
- Pawnshop loans: If your local pawnshop offers loans, you can exchange your asset for cash. You’ll likely pay an exorbitant amount of interest, and the pawnshop will keep your property if you default on the loan.
How to choose the best type of personal loan for you
You should consider reputable lenders that offer competitive interest rates and monthly payments you can afford.
When evaluating lenders, be mindful of the following:
- Does the lender offer rapid lending decisions and funding options?
- Does the lender charge loan origination or early repayment fees?
- Does the lender offer the type of loan you’re looking for?
- Does the lender offer the best terms based on your creditworthiness and intended use?
- As indicated by reviews, how do past and current customers perceive the lender?
- Are customer support representatives available during hours that work for your schedule?
- Is a mobile app available for you to apply and manage your loan while on the go?
Ultimately, a personal loan could be a good fit if you need a specific amount to make a purchase. But a line of credit may be ideal if you want the flexibility to borrow funds when you need them.
Pros and cons of getting a personal loan
Before applying for a personal loan, there are benefits and drawbacks to consider to make an informed decision.
- Flexible use. Most personal loans can be used however you see fit. Some lenders impose spending restrictions, though, so it’s best to read the fine print to avoid issues.
- Fast funding times. Many lenders disburse loan proceeds in just a few business days following approval – it could be as soon as 24 hours if you apply with an online lender.
- Borrowing costs. You’ll likely spend far less in interest on a personal loan than you would with a credit card. The average personal loan rate is 10.60 percent – this amount increases to 19.91 percent for credit cards.
- Fees. Some lenders charge loan origination fees and early repayment penalties. These hidden fees can make borrowing costs excessive.
- High interest rates. If you have a lower credit score, expect a higher interest rate as the most competitive terms are generally reserved for borrowers with good or excellent credit. That said, the higher monthly payment could stretch your budget too thin.
- Negative credit consequences. Lenders report payment history to the credit bureaus. If you encounter financial hardship and are unable to make timely payments on the loan, your credit score will likely take a hit if the loan reaches 30 or more days past due and the delinquency is reported.
There are several types of personal loans to choose from, but not all are the same. So, it’s vital to understand how each option works and what to expect before applying. Also, know which personal loans to avoid to protect your financial health, and evaluate lenders carefully to ensure you select the ideal personal loan product for you.