Personal loans are an accessible, flexible funding solution that can help you cover almost any significant expense. There are many types of personal loans, one for nearly any financial situation. This guide will dive into the details of various personal loan types so you can select the right loan for your needs.
Key Takeaways:
- Personal loans are a flexible financing solution, providing funds when needed; in return, you make payments to repay the money you borrow.
- There are many types of personal loans, such as secured loans, unsecured loans, lines of credit and debt consolidation loans.
- Personal loans can be used for various needs, including consolidating debt, paying for medical procedures, funding home renovations or financing wedding expenses.
How Do Personal Loans Work?
Personal loans let you borrow money for various reasons, from debt consolidation to home repairs. Borrowers typically shop across lenders to find the best loan available. Lenders consider your credit score and debt-to-income ratio when deciding what loan terms to offer you.
Personal loans require you to make monthly payments to repay your debt. The loan amount and interest rate will determine your monthly payment amount. Personal loans can have favorable interest rates, making them more affordable than other forms of debt. But like most loans, personal loans often have origination fees that you must pay up front.
Although personal loans typically don’t involve collateral, some lenders offer secured personal loans. If you have suboptimal credit, your lender might offer you a secured loan only, which is backed by collateral. Loans backed by collateral reduce the lender’s risk.
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Different Types Of Personal Loans
There are many types of personal loans. You should consider your unique needs when deciding which loan is best. Here are a few personal loan types that you might consider:
Secured Personal Loan
Secured personal loans are backed by collateral. You can pledge your home, car, or other asset. However, if you default on your loan payments, the loan terms allow your lender to take possession of the collateral as payment.
Since secured personal loans require borrowers to risk an asset as collateral, these loans often have lower interest rates. Secured personal loans allow borrowers with poor credit who would otherwise be ineligible for other loans to access financing.
Unsecured Personal Loan
Unsecured personal loans are one of the most common personal loan types. Borrowers with sufficient credit (usually 600 or higher) can access unsecured personal loans. Your credit score will determine how much you can borrow. Additionally, the better your credit score, the lower the interest rate you can obtain from your lender. It’s worth mentioning that unsecured personal loans rarely have as low an interest rate as secured loans.
Fixed-Rate And Adjustable-Rate Loans
There are fixed-rate and adjustable-rate personal loans.
Fixed-rate loans have an interest rate that never changes. This means that the monthly payment amount stays the same for the life of the loan. Fixed-rate personal loans are a good fit for borrowers who want predictable, fixed monthly payments.
Adjustable-rate loans, which are sometimes called variable-rate loans, offer borrowers an introductory period with an interest rate often lower than that of a fixed-rate loan. After the initial period expires, the interest rate adjusts and changes based on trends in the lending market.
Rate floors and caps govern how widely your interest rate can increase or decrease. Adjustable-rate loans are ideal for borrowers who can pay the loan off before the introductory interest rate ends. Borrowers who plan on carrying the loan debt for its full term may find a fixed-rate loan more favorable because the rate won’t increase.
Debt Consolidation Loans
Debt consolidation loans are a popular solution for borrowers facing multiple debilitating debts. Ideally, debt consolidation loans allow you to roll multiple debts into one new loan with a lower interest rate than that of the original debts.
These loans can be a helpful way to pay off credit card debt, which typically has high interest rates. Having one personal loan with an affordable monthly payment can make it easier to manage your debt.
Personal loans for debt consolidation are advantageous only if they save you money. Before taking out a loan, ask your lender to confirm the interest rate, whether the rate is fixed or variable, and your monthly payment amount. Debt consolidation loans have origination fees, so be sure to ask about those, too.
Revolving Credit
Another way to pay for expenses is with revolving credit. Revolving credit isn’t identical to a loan, but it acts as a reserve of funding that you can borrow against for a set number of years.
During the draw period (typically 10 years), you can withdraw cash from the line of credit, and you typically make interest-only payments. When the draw period ends, you enter the repayment period and make monthly payments toward the principal and interest.
Unlike traditional loans, you can borrow against sources of revolving credit, pay back what you owe and then borrow again from the same line of credit. Revolving credit solutions offer greater repayment flexibility compared to conventional loans.
Popular types of revolving credit include a personal line of credit and a home equity line of credit (HELOC). Personal lines of credit don’t require collateral but may have higher interest rates.
HELOCs may offer larger pools of cash or better interest rates, but your home is used as collateral. You risk losing your home if you can’t afford payments during the repayment period.
Installment Loans
Unlike revolving credit, an installment loan provides a certain amount of money, distributed as a lump sum. After you receive funding, you begin making payments toward the loan’s principal and interest.
Installment loans require you to make regular monthly payments on the debt. While installment loans might not have as low interest rates as revolving credit, they often come in smaller amounts. If you can afford the monthly installments, you can have peace of mind knowing that once you’ve made a set number of payments, you will pay off the loan.
But if you cannot pay the monthly installments, you will likely pay extra fees. And if you don’t communicate with your lender that you’re at risk of missing payments or defaulting on the loan, they may transfer the debt to a collections agency. Your lender may also send information about the missing payments to the three credit bureaus, which can negatively impact your credit.
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Other Types Of Personal Loans
Personal loans can range broadly by lender and how you can use them:
- Wedding loans are typically unsecured loans intended for wedding expenses.
- Vacation loans, which are also unsecured loans, can be used for vacation expenses
- Home improvement loans can help pay for home repairs or updates.
- Medical loans can help you pay off outstanding medical debts.
- Cosigned loans, which use a cosigner’s credit, let you access a loan or qualify for better terms because the cosigner is responsible should you ultimately be unable to pay back the loan.
- Payday loans are short-term loans that must be paid when you receive your next paycheck, but they aren’t recommended due to exorbitant fees and little regulation.
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How To Get A Personal Loan
Here’s how to get a personal loan: You’ll first need to meet credit score requirements (generally at least 600). If you have a lower credit score, you may be eligible only for secured loans or cosigned loans, and some lenders may decide not to work with you altogether.
After reviewing offers from multiple lenders and choosing a loan, prepare to present your lender with the personal documentation required to move forward:
- A driver’s license or other form of official identification
- Proof of income and employment
- A utility bill or mortgage statement for address verification
After reviewing your documentation and financial details, your lender will decide the specific terms of the loan they offer you. You can apply for a personal loan online or in person if your lender has physical locations, but applying online is often faster and more efficient.
Many lenders allow you to prequalify for a personal loan online. Prequalification can help you estimate borrowing limits and compare rates without impacting your credit score.
FAQ
Here are some answers to common questions about personal loans:
The Bottom Line: Choosing The Right Personal Loan
Personal loans are a versatile type of funding that you can use for almost any purpose, such as taking a dream vacation, consolidating debt or refinancing your home.
Because personal loans vary in functionality, it’s vital to review the terms of the personal loan your lender offers you. Interest rates, monthly payments and the consequences for missing a payment or defaulting on the loan can vary by lender and type of loan.
The right personal loan is one that not only meets your financial goal, but also fits comfortably within your budget.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
