Taking a personal loan entails borrowing money for just about any purpose, including but not limited to debt consolidation, an unforeseen medical bill, a new domestic device, a trip, or even a student loan. You pay the money back, together with interest, each month just like a regular bill. This is usually over a period of two to five years. For the most part, these loans are unsecured, which means there is no collateral in place to insure them. Collateral is something of value offered to the bank as an assurance you will pay back the loan.
There are also other types of personal loans that include variable-rate and secured loans. The type of loan you require depends on factors including how much time you need to repay the loan and your credit score. If it seems confusing, you are not alone. This quick guide helps to demystify the process so you can determine which loan may be right for you.
Types of Personal Loans
Unsecured Personal Loans
This type of personal loan is quite common, and collateral does not back it up. In general, collateral is a home or car. When no collateral is involved in securing the loan it makes lending a riskier business, possibly allowing lenders to set higher annual percentage rates (APR). The rate you get on this type of loan is based mainly on the basis of your credit score. Rates typically vary from five percent to 36 percent, and repayment terms range from one to seven years.
Secured Personal Loans
Unlike unsecured personal loans, secured loans are backed by collateral. This collateral is retained by the lender if you fall short of making the scheduled repayments. Examples of other secured loans include mortgages and car loans. Some online lenders, credit unions, and banks provide secured personal loans, where you borrow against the value of your car, savings accounts, or some other asset. Rates are usually lesser, because these loans pose less risk to the lender.
Personal loans almost always carry fixed rates, meaning that your rate and monthly payments or installments remain the same for the entirety of the loan. This can be good for you if you manage to secure a low interest rate because you are locked in at that lower rate, even if the APR should change in the economy.
These loans make sense if you want regular payments each monthand if you are worried about increasing rates on long-term loans. Having a fixed rate makes it simpler for you to make financial arrangements, as you do not have to stress about your payments changing.
Banks tie a benchmark rate to interest rates on these types of loans. The rate on your loan, along with your monthly payments and total interest costs, rise or fall with these loans, depending on how the benchmark rate varies.
A benefit of variable-rate loans is that they have lower interest rates than fixed-rate loans. Many set a cap on how much they can change over a period of time. This is a good idea if your loan is going to be paid quickly, as in general the rates will not increase over so short a time period.
Debt Consolidation Loans
This type of personal loan combines a number of debts into a single new loan. The loan is supposed to carry a lower annual percentage rate than those on your existing debts to save on interest. Consolidating also allows you to make just one monthly payment. This is a great idea if you have many creditors with varying interest rates because you can combine all of that debt into one payment at a lower interest rate. This may not be for you if you use it as an excuse to take out more credit or open up additional lines of credit.
This loan is for borrowers who may not qualify for a loan on their own due to bad or no credit history. Appointing a co-signer who has strong credit score can bolster your chances of qualifying and gets you a lower rate with more convenient terms. The downside to having someone co-sign a loan with you is that this other person is on the hook for the debt if you default. This may make it difficult to get someone to agree to the loan.
A Personal Line of Credit
This is basically revolving credit, relating to a credit card more than a personal loan. Instead of getting a chunk of cash, you get access to a credit line from which you can borrow whenever you need to. You have to pay interest only on the amount of money you withdraw. This works best when you need to borrow for ongoing expenses or emergencies, instead of a one-time payment. It can serve as a financial cushion against unforeseen emergencies.
Other Types of Loans
This is a type of unsecured loan, but it is usually paid back completely by the next payday. Loan amounts are generally a few hundred dollars or less. Such loans are high-interest, short term, and risky, loans. Most people who borrow these end up taking out additional loans when they fail to repay the first, entangling themselves in a debt cycle. That means interest charges raise quickly, and loans with APRs in the triple digits are not unusual.
Credit Card Cash Advance
You can make use of your credit card to get a cash loan from an ATM. This is generally considered a short term loan. It is a handy but expensive way to get cash. Interest rates are higher than those for purchases. In addition to this expect to pay a fee for making the advance. This can be either a dollar amount (around five to 10 dollars) or as much as five percent of the amount borrowed.
A pawnshop loan is a secured personal loan. You take a loan against an asset, such as jewelry, which you leave with the pawnshop. If you are unsuccessful in repaying the loan, the pawnshop puts your asset for sale. Rates for pawnshop loans are dreadfully high and can run to over 200 percent APR. But they are likely lower than those on payday loans, and you steer clear of damaging your credit or being tracked by debt collectors if you do not repay the loan. You simply lose your asset(s).