Secured and unsecured personal loans can be obtained from banks, credit unions, or online lenders, and they serve a variety of purposes.
If you’re thinking about taking out a personal loan to overcome a financial challenge or consolidate debt, you’re in good company. A recent Experian study revealed that the average consumer holds about $19,402 in personal loan debt. However, the suitability of a particular loan depends on your credit and financial circumstances.
Types of personal loans
Personal loans offer great flexibility, with varying rates, terms, and types to suit a wide range of credit profiles.
Before applying, check your credit score. This will guide you in deciding whether to pursue an unsecured or secured personal loan, and whether to consider a joint or co-signed option.
Additionally, have a clear understanding of your financing needs and financial goals. This will help you identify the most suitable loan type for your situation.
Knowing your requirements can also help you choose where to start your search, as different banks, credit unions, and online lenders offer different personal loan options.
Unsecured personal loans
An unsecured personal loan does not require collateral for approval. Instead, qualification depends on your credit score and income.
As a result, good or excellent credit is usually necessary to secure the best rates.
Some lenders also take your employment and education history into account.
If you default on an unsecured personal loan, you won’t risk losing any assets, but your credit will suffer. Additionally, you may incur high fees and potentially face legal action if you are unable to repay the loan.
Secured personal loans
Similar to auto loans and mortgages, secured personal loans require collateral for approval. Unlike loans backed by a car or house, a secured personal loan might use a certificate of deposit (CD) or a savings account as collateral.
Since the loan is secured, the lender assumes less risk and may offer lower interest rates compared to an unsecured personal loan. However, if you default, you risk losing the asset used as collateral, as the lender can legally seize it to cover the debt.
Debt consolidation loans
Debt consolidation loans are designed to help you pay off outstanding balances more quickly and save on interest. They also simplify the repayment process by combining multiple debts into a single monthly payment.
The goal is to secure a loan with a lower interest rate than what you currently pay on the debts—such as credit cards, medical bills, and other obligations—you intend to consolidate. You then use the loan to pay off these balances and make payments on the new loan over a set period.
However, be aware that your new loan may come with fees, such as an origination fee, which could reduce your savings. Additionally, ensure you have a plan to manage the loan effectively to avoid falling into deeper debt.
Co-signed and joint loans
If you can’t qualify for a personal loan on your own, a lender might approve you with a creditworthy co-signer.
A co-signer agrees to share equal responsibility for the loan without accessing the funds. They must also be able to afford the loan payments based on their income.
If you default on the loan and they don’t cover it, both of your credit scores will suffer.
Some lenders also offer joint loans, where both borrowers can access the loan funds. Like co-signed loans, both parties are responsible for the payments. Having a co-borrower with good or excellent credit can improve your chances of loan approval.
Fixed-rate loans
Fixed-rate loans feature an interest rate that remains constant throughout the repayment term. This means you make the same monthly payment for the duration of the loan, with each payment covering both interest and principal.
Most personal loans fall into this category. The stability of fixed payments makes it easier to budget effectively when you opt for a fixed-rate personal loan.
Variable-rate loans
The interest rate on a variable-rate loan can change based on market conditions, potentially offering a lower APR compared to a fixed-rate loan.
However, the downside is that the rate can increase over time. This makes budgeting for variable-rate loan payments more challenging due to their fluctuation. To mitigate the risk of rising rates, you might consider opting for a shorter-term loan to pay it off more quickly.
Personal line of credit
A personal line of credit provides access to a pool of funds that you can draw from as needed, similar to a credit card. You only pay interest on the amount you borrow.
This option is ideal for those seeking flexible access to funds at a better rate than a credit card. It can be useful for purposes like home renovations, overdraft protection, or covering ongoing emergencies.
Personal lines of credit usually have variable rates and can be secured by a banking asset, though unsecured options are available through online lenders or smaller banks.
Buy now, pay later loans
Buy now, pay later (BNPL) loans let you make a purchase without paying the full amount upfront. Instead, the total is divided into equal installments, usually to be paid in full within six weeks of the purchase date.
These loans are commonly offered through mobile apps like Afterpay, Klarna, and Affirm. Most lenders will review your bank activity and may conduct a soft credit check, which doesn’t affect your credit score.
This means you could qualify for a BNPL loan even with less-than-perfect credit if you have sufficient income to make the payments.
While on-time payments on BNPL loans are generally not reported to credit bureaus, late payments often are, which can negatively impact your credit score. Be cautious of overspending or taking out more BNPL loans than you can manage.
Types of loans to use sparingly
Certain personal loans come with exceptionally high interest rates and should only be considered as a last resort. For individuals with poor credit or limited access to traditional banking services, they may represent one of the few available options.
If possible, it’s advisable to avoid these loans altogether. However, if you find yourself in a situation where you need to use them, it’s crucial to stay on top of payments and strive to pay off the loan as quickly as possible.
- Credit card cash advances: Some credit card issuers offer the option to withdraw cash from your available credit at an ATM or bank. However, this convenience comes with significant costs, including a cash advance fee and a higher interest rate on the borrowed amount.
- Cash advance apps: These applications provide quick access to cash, typically up to $250, until your next payday. However, most lenders charge a monthly fee for this service, and you’ll need to repay the borrowed amount either on your next payday or within a two-week period.
- Payday loans: Designed for borrowers with poor credit, payday loans are an expensive form of debt. They often entail steep fees and interest rates well above 300 percent. Failure to repay can lead to a cycle of debt, particularly if you need to extend the loan term.
- Pawnshop loans: Some local pawnshops offer loans in exchange for your assets. While you can obtain cash quickly, you’ll likely incur substantial interest charges, and the pawnshop will retain your property if you default on the loan.
- Title loans: With a car title loan, you use your vehicle’s title as collateral. While these loans typically feature lower interest rates compared to unsecured options, missing payments can result in high fees or even the repossession of your car.
In Conclusion
Numerous types of personal loans are available, each with its own advantages and disadvantages. Before proceeding with an application, it’s essential to grasp the mechanics of personal loans and anticipate what lies ahead. Take the time to scrutinize potential lenders meticulously to ensure you secure the most suitable personal loan product for your needs.