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The Common Types of Personal Loans, Explained
A personal loan is money you borrow from a bank, credit union, online lender or another financial institution to use for a variety of reasons. It offers flexible repayment terms and fixed monthly payments. Nearly all personal loans are unsecured, which means you are not required to provide collateral. The best personal loans come with low-interest rates, which vary depending on your credit score and can range from low to very high.
Personal loans can be used to consolidate or pay off high-interest debt, fund home improvements, pay down medical bills, finance an unforeseen emergency and more.
The 7 different types of personal loans
Most personal loans are unsecured loans and do not require collateral to qualify. For that reason, lenders take on added risk so interest rates tend to be a bit higher than with a secured loan. Lenders may also be more apt to qualify applicants with good credit.
Personal loans are the fastest-growing form of consumer lending in the U.S., with a growth rate of 19.2% in the first quarter of 2019 year-over-year. That may be because personal loans can be used for so many reasons, from home improvements and expensive purchases to paying off credit cards and emergency car repairs.
[ Next: Is a Personal Loan My Best Option? ]
Amounts can range from $100 to $100,000. Annual percentage rates (APRs) vary, depending on your credit score and a number of other factors, but the average rate on a 24-month personal loan is 9.34%.
There are 21.1 million outstanding personal loans in the U.S. as of 2018. Most are unsecured, but many are secured by collateral, like a home or car. For that reason, many borrowers with weak credit may find it easier to qualify for a secured loan. Interest rates also tend to be lower and borrowers are also typically allowed to apply for larger amounts than with an unsecured loan.
Putting up collateral is a pretty good incentive to pay it back because you could lose your collateral or the lender can put a lien on your collateral if you default on your loan. Keep in mind that the approval process for a secured loan can often take longer than with an unsecured loan. Secured loans can be backed by vehicles, CD accounts, savings accounts and sometimes high-value personal possessions like jewelry — but it must be properly appraised.
Debt consolidation loans
A debt consolidation loan is a personal loan that allows you to roll all of your existing debt into one loan under one monthly payment. With a debt consolidation loan, it’s possible to reduce the total interest you owe, so you can pay off your debt faster. Interest rates, which are generally much lower than credit cards, vary a great deal and are usually based on your credit score. The better your score, the lower interest you’ll likely pay over time.
Like other types of personal loans, lenders do a hard credit pull for approval. This will impact your credit score in the short-term, but if you make your monthly payments on time and pay off your loan by the end of the term, you can improve your credit.
Personal lines of credit
A personal line of credit is usually unsecured and works much like a credit card, because you borrow and pay back funds as you draw from the line of credit. Personal lines of credit are good for long-term projects or if your income is somewhat irregular. You can usually get your money through a bank transfer or a line-of-credit check.
When applying for a personal line of credit, you are given a credit limit for the term of the loan. Limits usually range from about $1,000 up to as much as $100,000 or more. Interest only accrues on the amount you borrow until paid off. Although payoff times vary from one lender to the next, payment frequency options are typically weekly, bi-weekly, monthly or quarterly.
Cosigned and co-borrowed loans
A cosigned personal loan is guaranteed by someone who agrees to use their credit to help the borrower qualify for the loan. If the borrower defaults on the loan, the cosigner is responsible for the payments, which makes cosigning risky for the cosigner. However, if the loan is paid off on time, the borrower benefits greatly from the loan and can improve their credit.
On the other hand, a co-borrowed loan is a personal loan in which two people take out a loan together, making them both equally responsible for paying back the loan. The co-borrower also has part ownership in whatever the loan buys. Both a cosigned loan and a co-borrowed loan are best if your credit is poor, you have little or no credit or you have trouble qualifying for a personal loan.
Payday loans are short-term loans that are paid back on the borrower’s next pay day. Payday loans charge high-interest — some up to 400% — and are typically used by people who need cash fast but have bad credit and can’t qualify for a traditional loan. The amount you can borrow usually depends on what you earn, and you’ll likely have to provide a pay stub when applying.
Many laws — including Section 5 of the FTC Act; the Truth In Lending Act; Credit Practices Rules and the Electronic Fund Transfer Act — have been put in place over the years, to regulate interest rates, curb high fees and limit predatory practices used by credit bureaus and debt collectors. Some payday loan borrowers rollover their loan into a new one with the payday lender when they can’t pay it back. Unfortunately, this includes additional finance charges, and many borrowers end up repeat customers, living paycheck to paycheck.
[ Next: The Best Payday Loan Alternatives ]
Pawn shop loans
If you’re facing an emergency, your credit card is maxed out and you can’t qualify for a personal loan, a pawn shop loan may come in handy. A pawn shop loan lets you pawn an item of value in exchange for a lump sum of money for a set period of time. As long as you can repay your loan, plus interest, by the due date, the pawnbroker will return your item.
Unfortunately, pawnshop loans will only offer between 20% and 60% of the value of your item, so if your watch is worth $300, you may only get a loan for $150. Plus, loans are usually based on a term of 30 days, but for an additional fee some pawnbrokers will extend your term.
[ Keep reading: How to Get a Personal Loan With Fair Credit ]
Fixed-rate vs. variable-rate personal loans
When applying for a personal loan, it’s a good idea to know the difference between a fixed or variable rate loan.
Fixed-rate personal loan
A fixed-rate personal loan has a fixed interest rate that stays the same over the term of the loan. Your interest rate is determined at the time you apply for your loan based on your credit, and your payments remain the same over the entire loan. If the interest rate on your fixed-rate personal loan is relatively low, it is best to try to lock in your rate, especially if rates are about to increase. A fixed-rate loan is easy to budget, as your monthly payments won’t change.
However, fixed-rate loans usually start with a higher rate than a variable rate loan, and with a fixed loan, if rates fall, you have to live with the higher rate.
Variable-rate personal loan
Variable-rate personal loans have variable rates that can change over the life of the loan. Rates can change on a fixed schedule and are tied to a financial index. Unlike a fixed-rate loan, your starting interest rate on a variable rate loan can be lower and decrease if interest rates fall. Your monthly payments may also start out lower than with a fixed-rate loan that has the same term.
However, your payments could also rise if interest rates go up, and because the interest rate is variable, your monthly payments can also change, making it more difficult to budget.
Pros and cons of personal loans
Pros of personal loans
- Convenient funding
- Lower rates than credit cards
- Good for debt consolidations
- Most require no collateral
Cons of personal loans
- Higher interest rates than some loans
- Fees may applyAnother form of debt
- Hard to qualify with bad credit
Personal loans alternatives
Personal loans aren’t for everyone. If you have bad credit, it may be hard to qualify and get approved for a personal loan. Personal loans also sometimes come with higher interest rates than other alternatives.
Credit card: Credit cards are much like a personal line of credit that you draw on when you need funds. They often offer promotional rates, points, airline miles and more. Credit cards are also generally easier to qualify for, making them a good option for borrowers with poor credit.
Home equity loan or line of credit: A home equity loan and line of credit allow you to borrow against the equity you have in your home, up to 90% with some lenders. Home equity loans and lines of credit are best for someone who has equity built up in their home, want a low rate and can pay back the loan (or risk foreclosure).
410(k) loan: A 401(k) loan is drawn from your retirement account instead of from a financial institution. These are best for borrowers who can pay back the loan in less than five years. However, the employee benefits administrator must allow this type of withdrawal from your retirement account.
Salary advance: A salary advance is an agreement between you and your employer to lend either some or all of your next paycheck in advance. Depending on your agreement, you may or may not be required to pay interest on the loan.
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