Types of Personal Loans – Forbes Advisor

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When you have an unexpected expense or need to make a purchase that exceeds your savings, you may need to go into debt to get by. If you need flexibility, you can opt for a form of revolving credit, such as a credit card or line of credit.

But if you need a specific amount of money on a one-time basis, it might make more sense to take out a personal loan, an installment loan that is repaid over a set term or period. You repay monthly until the loan is fully repaid.

Some big banks don’t offer personal loans, and those that do tend to have strict credit score criteria and turn away customers without a credit score of 670 or higher. personal loans are hard to come by; many credit unions and a growing number of online lenders offer several types of personal loans.

Common uses of a personal loan

While it’s always best to use savings for big purchases and avoid getting into debt, sometimes that’s just not an option. Personal loans should not be used lightly, especially if you can pay the expenses while waiting and saving. If financing is essential, however, personal loans are often an attractive option as they often come with lower interest rates and higher limits than credit cards.

Some loans must be used for specific purchases, such as a car loan to buy a car or a mortgage to buy a house. But personal loans can be used for many purposes, such as:

  • Consolidation of higher interest rate debt, such as credit cards or student loans
  • Medical procedures not covered by insurance, such as fertility treatments or cosmetic surgery
  • Vacations or weddings you’d rather not wait to save
  • Home improvements or repairs
  • Major purchases such as an appliance

Types of personal loans

The most common type of personal loan is a fixed rate unsecured loan, but some lenders offer other options that you should be aware of when shopping around.

Unsecured Personal Loans

Most personal loans are unsecured, meaning no collateral is required to secure a loan. A car loan uses your car as collateral, so if you can’t make your payments, the lender can repossess your car.

On the other hand, an unsecured personal loan has no physical assets backing it up, so if you’re struggling to make the payments, there’s no asset the lender can take away from you. Your strong credit history, and possibly that of a co-signer, is what secures the loan. If you’re looking for an unsecured personal loan, you’ll usually need a good credit score (670 to 739) or better, according to the Experian credit bureau.

However, there are always negative consequences if you cannot repay your unsecured personal loan. If you make late payments, it can hurt your credit, and if you don’t make payments, your personal loan account could be subject to collections and destroy your credit score in the process.

Since unsecured loans require no collateral, they are inherently riskier for the lender, so you can generally only qualify for an unsecured personal loan if your credit is strong.

Related: Compare personal loan rates for 2020

Secured Personal Loans

If your credit needs improving, you may still qualify for a personal loan, but the lender may require it to be in the form of a secured loan. This means that you will have to provide something to guarantee the loan, such as a vehicle, a savings account or a certificate of deposit.

The good news is that the interest rate on secured personal loans is usually lower than that of unsecured loans. This is because there is less risk for the lender, since they can take your collateral if you cannot make your payments.

Fixed rate personal loans

Personal loans are generally fixed rate, which means the interest rate remains the same for the life of the loan, as does your monthly payment. The advantage is that you will know exactly how much your payment will be each month, which will make it easier for you to adapt it to your budget. You will also be able to know in advance how much interest you will pay over the life of the loan. A personal loan calculator can help you estimate your monthly payments before applying.

Adjustable rate personal loans

Although less common than fixed rate personal loans, some lenders offer adjustable rate personal loans. Rather than having the same interest rate forever, your interest rate is likely to change over time.

The appeal of adjustable rate loans, also known as variable or floating rate loans, is that the interest rate usually starts out quite low. After a certain period of time, the interest rate may increase depending on market conditions, so the monthly payment may increase or decrease.

Although there are usually caps in place to prevent you from paying more than a certain amount of interest, you run the risk of ending up with a higher rate and unpredictable monthly payments. For this reason, taking out an adjustable rate personal loan is generally only recommended if you can repay the loan quickly.

Alternatives to Personal Loans

Personal loans are ideal for certain expenses, but you may want to consider other options before deciding on the best type of financing for you:

  • Savings. This isn’t always possible if you need a loan to pay for an urgent expense, such as an unexpected home repair or emergency medical procedure. But if it’s something that can wait, it makes more sense to save up and pay cash. This helps you avoid paying interest and prevents you from going into debt, which can negatively affect your credit and overall finances.
  • Credit card. While personal loans are ideal for large, one-time purchases, credit cards are often best for small purchases over time. Part of the reason is that their interest rates are usually higher than personal loans, and you usually can’t borrow that much with a credit card. This is a form of revolving credit, which means you get a line of credit that you can use as needed. You only pay interest on what you use, and once you’ve paid off your debt, you can re-borrow up to the credit limit. Also, rather than repaying in fixed monthly installments, credit cards only require a minimum monthly payment. This offers more flexibility than personal loans, but since there’s no fixed repayment schedule or duration, it’s easier to get stuck in debt.
  • Lines of credit. A line of credit is another form of revolving credit, where you have a credit limit and only pay interest on what you borrow. You must repay a monthly minimum based on the amount you borrow, similar to a credit card, and you can re-borrow the funds. One option is a personal line of credit, which is similar to an unsecured loan. Another option is a home equity line of credit, which uses your home as collateral. However, lines of credit act more like loans in that you have a cash reserve to draw on rather than having to shop on plastic. When you have a line of credit, you typically access the money by writing a check or asking the lender to deposit it into your bank account.
  • Payday loans. Consumers with poor credit who find it difficult to qualify for personal loans may turn to payday loans as a form of quick cash, especially since lending standards are minimal and loan amounts are weak. But payday loans are considered a predatory form of lending since the fees are astronomical and add up quickly, according to the Consumer Financial Protection Bureau, leaving many people trapped in debt. Avoid them if possible.

If you have a major expense in life, there are many types of personal loans and other financing options to choose from. Just be sure to do your research, compare quotes from multiple lenders, and learn how a loan can positively and negatively impact your credit.

About Judith J. George

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