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Discover the different types of personal loans
By Aaron Crowe
Updated on May 29, 2023
Read time: 6 min
Personal loans can be used for just about any expense, including debt consolidation
Some personal loans require collateral, and others are based on your creditworthiness
A fixed-rate personal loan can be a great tool to help you reach a financial goal
As your situation changes, so does your financial plan. Sometimes you’re splitting the tab at the pub. Sometimes you’re saving up to buy a home. Sometimes, you need a loan.
Of the different loans out there for different situations, how do you know which one is right for your situation? Secured, unsecured, fixed-rate, variable-rate—lender language makes personal loans sound more complicated than they are.
Let’s look at a few examples.
Secured vs. unsecured personal loans
Secured loans are backed by collateral—that means you pledge something of value as a guarantee that you’ll repay the debt. Usually, that something is the thing you borrowed for—a car is the collateral for a car loan and a home is the collateral for a mortgage. But you can find secured personal loans, too. Some lenders offer secured personal loans if you have something of value to pledge, such as:
Car, boat, or RV
Life insurance policy with cash value
Valuable jewelry or artwork
Cash in Certificate of Deposit or other savings account
Anything of value that the lender is willing to accept
The way it works is that the lender puts a lien on the asset you’re pledging as collateral. A lien is a legal claim to that asset. It gives the lien-holder (the lender) the right to take steps to sell the asset and get paid back if you don’t hold up your end of the bargain. Liens are removed when the debt is paid off.
The idea of a lien might sound unappealing (cue the overplayed warning that the “lender can seize your asset if you default!!”), but in fact, it’s usually good for the borrower. Collateral lowers the risk of financial loss for the lender, so secured loans are often cheaper than loans that aren't backed by something of value. Most people don’t default and lose their asset.
For an unsecured loan, collateral isn’t required. Approval is based on your creditworthiness, your income, and how much other debt you have.
The interest rates can be higher to account for the extra risk of not having collateral.
Fixed-rate vs. variable-rate personal loans
Fixed-rate personal loans
A fixed-rate loan has an interest rate that’s set for the life of the loan. It'll never change, and your payment won’t either. A stable, consistent payment can help you budget for the future.
The downside is that if rates fall after you get your loan, yours will stay the same.
Most personal loans are fixed-rate loans. You’ll make the same monthly payment amount until the loan is paid off.
Variable-rate personal loans
If you come across a variable-rate personal loan, that means the interest rate can change while you’re paying off the loan.
The lender will follow a benchmark interest rate, such as the federal funds rate. The federal funds rate is the interest rate that banks charge each other overnight, and it’s the starting point for what they charge borrowers on loans and for how much they pay savers in interest. There are other benchmark rates, but the gist is the same. If the benchmark rate goes up, your rate goes up. If it goes down, your rate goes down.
Variable–rate loans often start at a very low introductory rate. This low rate might last a few months or a year. Then it goes up to the standard level for that loan and lender.
There are a couple of downsides to variable-rate loans.
One, the standard rate can be higher than what you’d pay for a similar fixed-rate loan. You won’t have any control over that.
Two, interest rate changes mean that your payment amount can fluctuate, making it a little trickier to budget.
A variable-rate loan can be a money-saving option for someone who expects to repay the loan in full in a very short amount of time.
Personal loan repayment terms
The loan agreement will tell you how long you have to repay the loan. This is called the loan term or the loan repayment period.
One nice feature of personal loans is that you can often pick the repayment term that fits your budget. The longer the loan term, the lower the monthly payment will be. Potentially good for your budget, but you’ll pay more interest over time.
A shorter loan term increases the required payment, but brings down your total interest charges.
Personal loan repayment terms usually range from two to five years, and go as long as seven years.
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Debt consolidation loans
A debt consolidation loan is an unsecured personal loan to pay off other debt. Debt consolidation loans have a fixed interest rate, so you’ll have the same payment due each month. A payoff date is set so you’ll know exactly when the loan will be paid off.
Some lenders are willing to pay off your other creditors directly, using your loan funds. This can speed up the time to pay off those other debts. If your interest is calculated daily (and most credit card interest is calculated daily), you could save money. Also, allowing your lender to directly pay off your creditors could get you a discount off your interest rate, for even more savings.
Credit card consolidation can relieve financial stress in a couple of ways. One, your monthly payment might be lower than the total of all the separate monthly payments you’re making now. Two, the loan might have a lower interest rate than the debts you want to pay off. Personal loans often have lower interest rates than credit cards do.
Payday loans are small personal loans, generally for $500 or less, usually due within 2–4 weeks. The way it usually works is you provide your bank details and give permission for the lender to take the money out of your account the next time you get a direct deposit.
Due to their short repayment period, most payday borrowers have a hard time paying them back by the due date and have to renew the loan multiple times. You can end up paying far more in fees than the amount you borrowed.
Payday loans may seem affordable, but the cost is extremely high compared to the loan amount. The APR (the cost of borrowing money) is typically between 400% and 800%. Compare that to a credit card cash advance, which usually has an APR of around 36%. (Both options typically also charge fees.)
Let’s put this in perspective.
Say you need to borrow $500. Your choices are a credit card cash advance, or the payday lender down the street from where you work. Fees vary, so for this example, we’ll ignore them and focus only on interest.
With a 2-week payday loan, you’ll need to pay back $577 after two weeks.
With the credit card cash advance, if you can afford to repay it after two weeks, you’ll pay back $507. And if you can’t afford to repay it in two weeks, you can take longer.
$500 cash advance at 36%
$500 payday loan at 400%
Payoff in 14 days
Payoff in 28 days
Payoff in 90 days
Even if you don’t have access to a credit card, payday loans will rarely, if ever, make your financial situation better.
Different types of personal loans
Most personal loans can be used for just about anything. They may be best for short- or mid-term purchases, such as an emergency or a large expense you want to pay for over time. A long-term purchase, such as a home, isn’t an option for a personal loan, though a car loan may be.
Here are some common uses for personal loans:
Home appliance repair or purchase
Frequently asked questions
What’s the easiest type of personal loan to get approved for?
Just about anyone with regular income can walk in and get a payday loan. But you shouldn’t. It’s an expensive solution that isn’t designed to get you to the next level of financial success.
Secured loans tend to be easier to get than unsecured loans, because if you have something of value to borrow against, the lender might be more flexible with credit requirements. If you have property or savings, you might be able to borrow against it.
Another option is to look at other loan types. For instance, if you’re a homeowner, a home equity loan might be an option even if your credit score is lower.
What are the two types of personal loans?
Secured and unsecured are the two main types of personal loans.
Secured loans require something of value that you can pledge as a guarantee that you’ll repay your loan. Unsecured loans don’t require collateral. They are based on your creditworthiness, income, and other debts.
Can I use a personal loan to pay off credit card debt?
Yes. A personal loan for debt consolidation is a common way to pay off credit card debt, often at a lower interest rate compared to credit cards.
What advantage does a personal loan have over credit card debt?
A personal loan has several advantages over credit card debt. It offers a fixed interest rate and payment amount, which makes budgeting and planning easier. You can also typically repay the loan faster, as the amount isn’t subject to fluctuating interest rates. Plus, it’s often cheaper than carrying a credit card. Finally, it can help improve your credit score over time if you make timely payments.
Can I pay my credit card bill with a personal loan?
It's important to note that you cannot directly pay your credit card bill with a personal loan.
However, you can use a personal loan to pay off your credit card debt. Doing so can simplify your debt by consolidating multiple credit card balances into a single loan with a fixed interest rate and payment amount. This can potentially help you pay off your debt faster and save money on interest charges.
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