Different types of personal loans can help you do many different things. They could help you make large purchases, consolidate other types of debt, pay medical bills, and even help you out in an emergency. It’s a very versatile form of borrowing used by many people to address all kinds of needs. Choosing the right kind of personal loan could help you make financially responsible decisions regarding how and why you borrow.
Personal loans usually have lower interest rates than credit cards. That’s why they often are used for debt consolidation, where multiple credit card debts are combined into one monthly payment at a lower cost. Also, paying back a personal loan is different from repaying credit card debt. With a personal loan, you borrow money and pay it back in fixed installments over a set period of time. This continues until the debt is completely repaid.
Terms you should know before taking out a personal loan
- This is how much you borrow. Lenders will base their interest calculation on the principal you owe. As you pay the money back, the principal amount decreases.
- You will repay your debt with interest when you take out a personal loan. This is what the lender charges for allowing you to use their money and gradually pay it back. You’ll pay interest every month in addition to your monthly principal payment. Interest is usually charged as a percentage of your owed principal.
- APR stands for “annual percentage rate.” When you take out any loan, in addition to the interest, the lender will typically charge lender fees. APR incorporates both your interest rate and fees to give you a better sense of the actual cost.
- Loan term. This is how much time you have to repay the loan. When a lender approves your application for a personal loan, they’ll tell you the loan term.
- Monthly payments. Every month during the loan term, you’ll have a payment. This will include money toward paying down the principal of the amount you owe, as well as part of the total interest you’ll owe over the span of the loan.
The types of personal loans
Choosing the right type of loan should not be taken lightly. It’s important to take into account your credit score and how much time you need to repay the loan. Here are some of the types of personal loans and how they’re used:
Unsecured personal loans
With unsecured loans, there’s no collateral involved. A personal loan is usually an unsecured loan — backed only by the good credit of the borrower or cosigner.
Secured personal loans
Secured loans are backed by collateral. This means that the lender can take the items you present as collateral if you don’t repay the loan. With home-equity or auto loans, the property you’re buying serves as collateral to the lender. Some financial institutions let borrowers secure a loan with personal savings or another asset. Secured loan APR rates are typically lower than unsecured loan rates.
Most personal loans carry fixed rates. This means your APR rate and monthly payment installments stay the same over the course of the loan. Fixed-rate loans make sense if you want the same payment amount each month. They’re also helpful if you’re concerned about rising interest rates and want to lock in a rate. It can be easier to budget when you don’t have to worry about fluctuating payment amounts.
Interest on variable-rate loans is tied to a benchmark rate set by banks. Depending on their fluctuation, the rate on your loan, total interest costs, and monthly payments can change.
Variable-rate loans tend to carry lower APRs than fixed-rate loans. They might also have a limit on the APR variability over a specific period and over the loan’s term (meaning there are limits on how high – or how low – your interest rate can go).
Co-signed and joint loans
Co-signed and joint loans are best for people who can’t get a personal loan on their own or want a lower APR rate, but co-signed loans and joint loans are not the same thing.
A co-signer on a loan promises to repay it if the borrower can’t. However, the cosigner doesn’t have access to the funds from the personal loan.
A co-borrower on a joint loan is liable if the other borrower doesn’t make payments, and they can access the funds from the loan. Having a cosigner or co-borrower with strong credit may improve your chances of qualifying, and they might also get you a lower rate or better loan terms.
A debt-consolidation loan merges multiple debts into one new loan. That way, you have a single monthly payment. Debt consolidation loans may be a wise choice if they carry a lower APR than the rates on your current debts. That way, you save money on interest.
Buy now, pay later loans
“Buy now, pay later” (BNPL) are types of loans that let you split an online purchase into smaller payment installments. You create an account with an app at checkout, and once you pay for part, you then authorize the app to let you pay the rest in installments. Common apps include AfterPay, Affirm, and Klarna.
BNPL installment loans work best for important, one-time purchases that you wouldn’t be able to buy with cash. BNPL apps review your bank account and its transactions and may do a soft credit inquiry before allowing you to set up your account.
A personal line of credit
This is a type of revolving credit account. In essence, it’s more like a credit card balance than a personal loan. Rather than getting a lump sum of money, you get a credit line to borrow from as you need it. You only pay interest on the borrowed amount. A personal line of credit can be helpful when you have ongoing expenses rather than a one-time purchase.
A credit-builder loan can help people who have little or no credit history. You don’t need good credit to get approved, but they do require that you have enough income to make payments. These loans could help people get on the map with a credit score. And establishing a good credit history could help later with approval for credit cards and loans.
If you are approved for the loan, the borrowed amount is held in a bank account while you make payments. Typically, you can’t access the money until the loan is fully repaid. That way, you can build savings and credit at the same time.
Choosing the right type of personal loan
The best personal loan is the one that is right for you and your current needs. Explore your options, use a loan calculator tool to determine what you can afford, and make your choices wisely. There are lots of choices when it comes to personal loans and being armed with knowledge is the first step to selecting the right one for you.