When you need extra money for home repairs, debt consolidation, or anything else, a personal loan can be a helpful financial tool. However, with different types of personal loans available, it can be overwhelming to determine which one best suits your situation.
Personal loans come in many forms. Some require collateral, while others don’t. Some personal loans have fixed rates, while others have variable rates. Understanding the different types of bank loans can help you make an informed decision that fits your budget and goals.
In this guide, we’ll walk you through various types of loans, explain how each one works, and help you understand what kinds of personal loans might be right for your specific needs. We’ll also cover some loan options you should approach with caution so you can avoid potential financial pitfalls.
- What are the different types of personal loans?
- Types of personal loans to use with caution
- Which type of personal loan is best?
- Choosing the right personal loan for your needs
What are the different types of personal loans?
If you’re considering applying for a personal loan, there are a few loan options to consider. It’s best to research and understand the various types of loan options available so you can determine what’s right for you and your specific financial needs.
Secured personal loans
A secured personal loan requires that borrowers offer collateral, or something of value, to the lender. For example, the rights to your home or car to protect (or secure) the lender. The lender then places a lien on that asset until you repay the loan in full. If you can’t pay off the loan at all (default), the bank or lender will seize your collateral.
Because of the collateral that borrowers provide, these types of loans are often easier to qualify for and have lower interest rates, larger borrowing limits, and longer repayment terms. This is because the bank is better protected against loans not being paid.
However, you may lose a valuable asset with a secured loan. This type of personal loan must also be used for a specific purpose.
Common types of secured loans include mortgages, auto loans, home equity line of credit, business loans, and land loans.
Secured loans are often for large amounts, which is why banks or lenders must protect themselves in the event the borrower can’t repay the loan amount.
Unsecured personal loans
Unsecured personal loans are loans that don’t require collateral. As long as you meet the bank’s borrowing requirements, all you need to do to get an unsecured personal loan is sign for it. This is why they’re sometimes referred to as “signature loans.”
Since lenders aren’t protected by collateral like they are with secured loans, they often charge higher interest rates or require higher credit scores for unsecured loans, as the loan is a greater risk for them.
If you can’t pay an unsecured personal loan and default, the bank will send the debt to a collection agency and negatively impact your credit score. Higher interest rates on unsecured personal loans help cover the bank financially in case of missed loan payments.
Unsecured loans are very common, especially for those who have a good-to-excellent credit history and a steady source of income. They can also be used for anything you want. For example, home improvement or car repairs. Student loans and credit cards are considered unsecured loans.
The only downsides to an unsecured loan are the fact that you need good credit and steady income and that interest rates are higher than secured loans.
Debt consolidation loans
Many people owe money on multiple loans, such as credit cards, and struggle to pay them all off, which ultimately decreases their overall credit score. That’s where obtaining a personal loan for debt consolidation can help.
A debt consolidation loan combines multiple debts into a single loan with one monthly payment, and sometimes even a lower interest rate. This helps many people better keep track of their debt (after all, one payment is better than four or five!) and potentially save you money on interest. This can also help you pay down your debt faster.
With a debt consolidation loan, you’ll apply for a loan in the amount you owe on your current debts. Once you’re approved by a lender like a credit union, you’ll use that loan money to pay off your existing debts. That will leave you with only the debt consolidation loan amount to repay over the agreed-upon terms of the loan.
Co-signed and joint loans
A co-signed loan involves two people, but only one person is responsible for using the money. The co-signer agrees to repay the loan if the primary borrower is unable to make payments. This arrangement enables individuals with poor credit or limited credit history to qualify for more favorable loan terms.
On the other hand, joint loans involve two people who are both equally responsible for the debt, and both have access to the loan funds. Both types can help you get approved for larger amounts or lower interest rates. However, they may also put relationships at risk if payments are missed.
Personal line of credit
A personal line of credit works similarly to a credit card but offers lower interest rates. You’re approved for a maximum credit limit, and you can borrow money as needed up to that limit. You only pay interest on the amount you use, not the entire credit limit.
This flexibility makes it useful for ongoing expenses or emergencies where you’re not sure exactly how much money you’ll need. Once you pay back what you’ve borrowed, that credit becomes available to use again.
Fixed-rate loans
With this type of loan, your interest rate stays the same. This means your monthly payment amount won’t change, making it easier to budget and plan your finances. Most traditional personal loans have fixed rates, which gives borrowers predictability and protection against rising interest rates.
The downside is that if market rates drop significantly, you’ll still be stuck paying the higher rate unless you refinance.
Variable rate loans
Variable-rate loans have interest rates that fluctuate over time in response to changing market conditions. These loans often offer lower rates than fixed-rate loans initially, which can save you money in the short term. However, your monthly payment may increase if interest rates rise, making it more challenging to budget.
This type of loan works best for borrowers who can handle payment fluctuations.
Buy now, pay later loans
Buy now, pay later (BNPL) loans allow you to purchase items immediately and break the cost into smaller payments over time. In most cases, you won’t be charged interest as long as you make timely payments. These loans are commonly offered at online checkouts or in stores for purchases ranging from clothing to electronics.
While they seem convenient, these loans can lead to overspending and multiple payment due dates that are hard to track.
Types of personal loans to use with caution
While there are many legitimate loan options available, some personal loan types carry significant risks. These loans often target people in financial emergencies with promises of quick cash, but they typically charge extremely high fees and interest rates.
Before considering any of these options, it’s important to understand the potential consequences and explore safer alternatives.
Payday loans
Payday loans are short-term, high-cost loans that are supposed to be repaid with your next paycheck. These loans often charge high fees, making them one of the most expensive borrowing options available. Many borrowers find themselves unable to repay the full amount when it’s due, so they roll the loan over and pay additional fees. This creates a dangerous cycle where borrowers pay more in fees than they originally borrowed.
Credit card advance
A credit card cash advance gives you cash from your credit card, but this type of loan comes with immediate costs and high interest rates. Unlike regular credit card purchases, cash advances start accruing interest right away with no grace period, and they often charge additional fees based on the amount withdrawn.
Pawnshop loans
Pawnshop loans require you to leave a valuable item as collateral in order to borrow money. If you don’t repay the loan on time, you lose your item permanently.
These loans often charge high monthly fees and interest rates, and the loan amounts are usually small compared to the value of what you’re risking.
Title loans
Title loans use your car’s title as collateral for a short-term loan, but they come with extremely high interest rates. Even though you can keep driving your car while repaying the loan, the lender can repossess it if you miss payments.
Cash advance apps
Cash advance apps offer small amounts of money before your next payday, often marketed as fee-free alternatives to payday loans. However, many of these apps encourage tips that can add up to high interest rates, and some charge monthly membership fees or expedited transfer fees.
While they might seem convenient, relying on these apps can create a cycle where you’re constantly borrowing against future income, making it hard to build financial stability.
Which type of personal loan is best?
There’s no single “best” personal loan that works for everyone. The right choice depends entirely on your individual financial situation, credit score, income, and what you need the money for. What works perfectly for your neighbor might be completely wrong for your circumstances.
Your credit score helps determine the loan options available to you and what interest rates you’ll qualify for. Someone with excellent credit might easily get approved for an unsecured personal loan with a low fixed rate. In contrast, someone with poor credit might need to consider a secured loan or find a co-signer. Your income stability also matters since lenders want to see that you can reliably make monthly payments.
The purpose of your loan should also guide your decision. If you’re buying a house, a mortgage makes sense. If you need to consolidate high-interest debt, a debt consolidation loan could save you money. If you need a one-time lump sum for a specific purchase, a traditional personal loan with fixed payments could be the simplest option.
Consider using a personal loan and payment calculator to help you estimate payments and compare loan amounts and terms.
Choosing the right personal loan for your needs
Understanding the various types of loans available is the first step in making a smart borrowing decision that aligns with your financial goals. Whether you need an unsecured personal loan for home improvements, want to consolidate debt, or are exploring your options for the first time, choosing the right loan can save you money.
At Sun Loan, we understand that everyone’s financial situation is unique, and we’re here to help you get a personal installment loan that works for your specific needs. Apply for a personal installment loan today or learn more about how to get a personal loan.
