You may think that all personal loans work similarly, and in many cases, you will be right. However, there’s always a blot on the landscape. At some point, you may find out that there are personal loan options that differ significantly from what you used to call this way. Additionally, direct lenders are not created equally. They set different terms for their products, making them vary widely.
The sooner you will understand how personal loans differ, the easier it will be for you to choose the right one. Let’s talk about different types of personal loans and take a look at some examples.
Table of Contents
Personal Loan Meaning
A personal loan is a borrowing option that provides you with money that you can use to finance various life projects. Personal loan lenders often don’t track the way you use the borrowed amount. Thus, most loans you take on various specific needs are simply personal loans, whether they are called dental loans or vacation loans. This is because the lender gives you the funds on hand and doesn’t check whether you use the loan for its intended purpose.
You can get a personal loan from a traditional financial institution, online personal loan lender, or private lending companies. Each lender may offer its personal loan terms, but most of them will share some similarities.
Most personal loans generally come in the form of a lump-sum deposit that a borrower gets into their bank account. Another common feature of many personal loans is their flexible repayment schedules. This allows customers to return the money borrowed in equal monthly payments, reducing the toll on their budgets. However, some options may also come with lump-sum repayment and have pretty short repayment terms.
Types of Personal Loans
Personal loans can be divided into several categories based on the following parameters:
In terms of repayment guarantees required: secured personal loans and unsecured personal loans.
In terms of interest rate fluctuation: fixed-rate personal loans and variable-rate personal loans.
Also, there are options that may look similar to personal loans but have specific purposes. These loans may be more favorable for people who want to get extra money for that objective.
Let’s take a closer look at each category.
Unsecured Loans
An unsecured loan is a debt that has no repayment guarantee except for your signature in a loan agreement. Therefore, these loans are also known as signature loans. Lenders that offer unsecured personal loans are usually more exacting and have stricter eligibility requirements. This happens as a lender takes more financial risk and is forced to do thorough data research to ensure you’re a reliable borrower.
Additionally, unsecured loans usually have higher interest rates compared to options with collateral. According to the Bankrate study, the average unsecured loan interest rate is now about 10.99%. However, the exact rate you will be offered depends on many side factors. Your credit score is usually one of the most important criteria. The lower a borrower’s credit score, the higher rate they may get.
Below are some examples of unsecured loans for personal needs.
Traditional Personal Loans
A traditional loan is form of debt offered by a conventional loan provider, such as a bank or credit union. Before getting approved for a traditional loan, you need to undergo a hard credit check. This means that your credit score may temporarily drop by a few points. Traditional options usually have repayment terms of up to 60 months. The loan amount you can request can be up to $100,000 depending on your income.
Bad Credit Loans
Bad credit loans are options that are typically offered by alternative online lenders. The main things they are known for are relaxed eligibility criteria, almost guaranteed approval, and high interest rates. The most popular bad credit loans are payday loans and online installment loans.
Payday loans typically have repayment terms that don’t exceed 30 days. Instead of making equal monthly payments, you must pay it off in full on the due date. The amount you can get is usually up to $1,000. However, some states may limit them to $300 or $500.
Additionally, payday loans come with one of the highest interest rates among all loan options. Their annual percentage rate can be over 400%. Therefore, payday loans are banned in some states. Installment loans for a poor credit score are more similar to traditional personal loans. They are also repaid in affordable monthly installments but have higher interest rates, smaller amounts, and shorter repayment terms. You can get up to $5,000 and repay the loan funds in 3 to 24 months. Interest rates on installment loans range between 16% and 100% APR.
Additionally, there’s a payday alternative loan (PAD) that can be obtained from a credit union. This option has longer repayment terms and interest rates that are capped at 28%, making it more budget-friendly. To get one, you need to be a member of a certain credit union that has PADs on the list of its loan products.
Secured Loans
A secured loan refers to a form of debt that requires some of the borrower’s assets to secure the loan repayment. This means that you can borrow money only after providing collateral. The property pledged must be owned by a borrower and have a value that equals or exceeds the requested sum.
Secured loans are less risky for lenders. This is because they can always get their money back by repossessing a borrower’s property. Therefore, they come with lower interest rates and more lenient credit score requirements. If you have good credit, you can be offered an APR between 3% and 6%. Additionally, you can get more favorable terms, for example, an extended repayment period or a lower down payment required.
At the same time, a borrower must provide a lender with partial ownership of the asset. Thus, if you get a secured loan and default on it, you will lose the property pledged. Below are some secured personal loan options available.
Credit Builder Loans
These loans can help people with no or bad credit establish it or improve their credit scores. They differ much from regular personal loans. Instead of getting a lump sum deposit, you make regular monthly payments to a lender upfront. You can’t use the amounts you pay until the loan term comes to an end. This way, you demonstrate responsible financial behavior. When the loan term ends, you can access the whole amount and use it at your discretion. By making regular payments, you increase your credit rating.
Share Savings Loans
This loan allows you to borrow money against the balance of your savings account. The amount you have in savings typically equals the maximum loan amount you can get. Thus, the lender can withdraw money from your savings account in case of defaults or payment delays.
Co-Signer Loans
To get a co-signer loan, you don’t need to provide any physical asset. Instead, you bring a co-signer with good credit and high income. If you default on a loan, this person will be responsible for repaying the remaining amount.
Title Loans
This secured personal loan allows you to get up to 50% of your car’s value by using it as collateral. The good part is that you can still use your car during the pledging period. The bad news is that car title loans work similarly to payday loans, meaning that the money must be repaid all at once by your next paycheck. This way, title loans come with a high risk of losing your vehicle.
Fixed-Rate Loans
A fixed-rate loan is a personal loan with an interest rate that doesn’t change during the whole loan period. This way, your monthly payments are always predictable. Even if significant economic changes come, your interest rate won’t fluctuate. Therefore, fixed-rate loans are good options for people who are looking for stability.
Variable-Rate Loans
Also known as adjustable-rate loans, these options come with costs that can fluctuate. This may happen under various economic conditions or at a lender’s discretion. Interest rate fluctuation means that there’s always the risk of a loan price hike. You never know for sure what your next monthly payment will be. At the same time, loans with variable interest rates usually have lower initial APR. Just keep in mind that they are riskier than those with fixed rates.
Loans for Specific Purposes
As the name suggests, such loans have strict restrictions on the way you can use them. In most cases, lenders don’t give you money on hand. Instead, they transfer it directly to a retailer or service provider. Below are a few examples of specific-purpose loans.
Debt Consolidation Loans
A debt consolidation loan allows you to replace all your outstanding loan balances with one new loan. It’s usually used to make your existing debts easier to manage. This is because you will have a single payment instead of multiple ones.
Sometimes debt consolidation loans come with lower interest rates than those of your existing loans. This way, you can either get lower monthly payments within the same period or reduce the repayment term. In both cases, you’ll save money on interest.
When it comes to a debt consolidation loan, a lender gives you a balance transfer card. Such a card allows you to only make a transfer from one account to another.
Auto Loans
An auto loan can be used only to purchase a vehicle. If you and the car you choose meet the lender’s requirements, you can get up to 90% of your automobile’s cost with a loan. The funds will be transferred directly to a car seller, so you won’t get them on hand. Plus, your automobile will be used as collateral.
Private Student Loans
A private student loan is a borrowing option that people use to finance any of their education-related needs. In most cases, students turn to private financing when they already maxed out their federal student aid options. Private student loans allow borrowers to pay for tuition, dorm, books, or any other costs they may face while studying.
Personal Loan vs. Personal Line of Credit
A credit line can be a better solution than a personal loan in some situations. For example, if you face a short-term financial emergency, fixing it with the help of a credit line will be much cheaper than by using a payday loan. While a 14-day payday loan may cost you nearly $45 for $300 borrowed, your credit card interest will be about $3. Also, some credit card issuers offer interest-free promotional periods. Thus, a cardholder can save significantly, provided that they will repay the amount within this term.
Additionally, credit cards usually have higher limits. Another benefit is that you will always be ready for some unplanned expenses. You can use a credit card from time to time when necessary without undergoing any application and verification processes. However, it can lead to overspending or buying unnecessary items.
What to Pay Attention to When Choosing a Personal Loan?
Whatever loan you decide to get, keep in mind that it always comes with responsibility. Make sure you can afford the amount you need to repay each month without sacrificing your essentials. Also, when choosing a loan, pay attention to the following factors:
- Your credit score. As some loan options require you to have good or excellent credit, review your credit scores through all three major credit bureaus. This way, you will understand whether you meet their minimum credit score requirements.
- Interest rates. The lower your interest rate, the less you will overpay in the long run. Thus, you should compare offers from multiple lenders and choose the one with a lower APR.
- Repayment schedule. Choose the repayment term that suits your budget. Also, keep in mind that a longer term comes with lower monthly payments but always results in more overpayment.
- Loan purpose. If you’re taking out a loan for some major purchase, consider a specific purpose loan. For example, it can be much cheaper to get a mortgage or an auto loan than to use a personal loan to finance your house or vehicle.
- Collateral. Although a secured personal loan can come with a lower APR, it also carries more risk to you. Assess your ability to repay the money thoroughly before pledging your property. If you’re not sure, it’s better to consider an unsecured personal loan.
Bottom Line
A personal loan is an option provided by banks, credit unions, and online lenders without tracking the way you use the borrowed amount. There are different types of personal loans designed to meet the demand of various groups of borrowers. In terms if collateral required, there are unsecured and secured personal loans. When it comes to interest rates, there are fixed-rate and variable-rate loans. Learn more about each option to choose the one that better suits your current purpose and financial situation.
