If you want to use a personal loan to get over a financial hump or consolidate deb, you’re not alone. According to a Bankrate study, the average consumer carried personal loan debt of around $16,458 in 2020. Before you move forward with borrowing the funds you need, you should compare the types of loans that are available.
What is a personal loan?
A personal loan is a debt product available through a bank, credit union or online lender. It’s commonly used to cover a financial emergency, make home improvements or consolidate debt. Most personal loans are disbursed as a lump sum and payable in installments over a set period, generally between one and seven years.
Expect to pay between 4 and 36 percent in interest, depending on your creditworthiness and loan product you select.
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 that serves as collateral. For example, you could take a loan out against your vehicle, which is 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’re currently paying 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.
Personal loan types 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 hand over your asset in exchange 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
Ultimately, you want a loan product from a reputable lender that offers a competitive interest rate and monthly payments you can afford. It’s equally important to consider the most suitable options based on your creditworthiness, financial situation and intended use.
A personal loan could be a good fit if you need a set 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 meets your borrowing needs.