When you are in need of a large amount of cash, you may consider options like taking out a credit card or borrowing from your loved ones. Unfortunately, credit cards can be potentially dangerous to your finances due to the high interest rates and borrowing from your family and friends can be risky for your relationship if you are unable to pay it back.
Personal loans come without these risks when you need cash. Below, we break down what you need to know about personal loans and the types of personal loans that are best for your situation.
What Is A Personal Loan?
Personal loans are installment loans that you repay with a monthly payment over a period of time. If you have good credit, you are more likely to qualify for lower interest rates than what you would receive with a credit card.
While you can take out loans with bad credit, your interest rates will be much higher and your loan terms won't be as favorable.
Why Should I Take Out A Personal Loan?
The potential uses of personal loans are nearly endless. Some of the most common reasons that consumers take personal loans include:
- Credit card debt consolidation
- Loan refinancing for high-interest debt
- Financing a small business
- Medical expenses and bills
- Large purchases
- Home renovation
When Should I Consider A Personal Loan?
If you are on the fence about whether or not to take out a personal loan, consider the following before deciding if it is more beneficial than using your credit cards:
- You want to consolidate and pay off your high-interest debt in a lump sum.
- You plan on refinancing high-interest debt.
- You plan on making a big purchase and you prefer having a lower interest rate with a personal loan (around 7% with good credit) than the higher ones associated with credit cards (around 15%).
- You need to fund a large home improvement project and you prefer not to take out a lower-interest home equity loan that requires you to put up your house as collateral.
- You need to cover medical expenses. However, if you can receive a payment plan through your doctor's office, that may be a better option since you can avoid interest.
- You have a small business purchase to make. (In this case, you can also consider a small business loan).
There are also times when taking out a personal loan isn't the best decision. For example, you can use one to fund a non-essential venture like a vacation or wedding, but we don't recommend this if you know you can save up for it over time and avoid added interest in the future.
Types Of Personal Loans
There are multiple types of personal loans that vary based on circumstances like your credit score and the time needed to repay your loan.
If you are unsure of where your credit stands, you can use a credit monitoring service to help you find and keep track of your credit score.
If your credit needs a little improvement, you can contact a credit repair company for assistance or fix your credit on your own.
The following list contains the most commonly used personal loans.
Debt Consolidation Loans
Best For: Consumers who are looking to pay off multiple, high-interest debts and have trouble keeping up with their current payment schedules or paying more than the minimum amount due.
Debt consolidation is one of the most widely used purposes of a personal loan because it allows you to combine all of your high-interest debt and pay it off with a single lump sum. The advantage of this is you will most likely have a lower interest rate on all of your current debts and one fixed monthly payment.
While you can use a personal loan for the purpose of debt consolidation, you may also want to consider other forms of debt relief like debt settlement or credit counseling.
Fixed Rate Loans
Best For: Consumers who have long-term loans without fluctuating rates.
The majority of personal loans have fixed rates that allow the monthly loan payment and interest rate to stay the same throughout the entire loan term. These interest rates are generally higher than variable rate loans; however, since the interest rate does not fluctuate, you can plan for the exact payments each month.
Variable Rate Loans
Best For: Consumers who are looking for short-term loans with lower interest rates.
Variable-rate loans have interest rates that fluctuate depending on the benchmark rate set by banks. This means that your monthly payment and interest increases or decreases based on economic changes.
Many consumers choose variable-rate loans because they generally have lower interest rates than fixed-rate loans, along with a cap that prevents these rates from becoming too high during the loan term.
These loans are ideal for short repayment terms since the interest rates probably will not rise too high during the repayment period.
Unsecured Personal Loans
Best For: Consumers looking for less risky loans that are not backed by collateral.
Most personal loans are unsecured personal loans, which means they aren't backed by collateral like your home or vehicle.
These loans are riskier for lenders, which is why they carry higher interest rates than secured loans.
Interest rates are usually between 5% and 36% and repayment terms last from 1 to 7 years.
Secured Personal Loans
Best For: Consumers who are looking for loan terms with lower interest rates and are sure they can make on-time payments despite the risk of losing their collateral.
Secured personal loans are backed by collateral, which means that if you default on your loan the lender can seize your assets.
Some examples of collateral include your home for mortgages, your vehicle for auto loans, or even your personal savings if you take out a secured personal loan with a bank or credit union.
Interest rates are generally lower than unsecured loans since these are considered less risky by lenders.
Best For: Consumers who are new to credit or have thin credit and may not qualify for a loan without the help of a family member or friend with good credit.
Co-signed loans help consumers who have no or limited credit to qualify for a loan. If your co-signer has a high credit score, you may qualify for lower interest rates. Your co-signer must also guarantee to repay the loan in case you default.
Personal Line of Credit
Best For: Consumers who need steady funds for recurring emergencies.
A personal line of credit is similar to a credit card. Instead of receiving a large amount of upfront cash, you will have a line of revolving credit that you can use when you need it and you only required to pay interest on the amount you borrow.
Best For: While we don't recommend cash advances due to the high interest rates, these can be used in an emergency.
Credit card cash advances allow you to receive a short-term cash loan from a bank or ATM. However, the interest rates and fees associated with cash advances are high -- around a $5 to $10 fee or 5% of the borrowed amount.
Best For: While we generally don't recommend pawnshop loans due to the high interest rates, these loans can be used in a pinch.
Pawnshop loans are secured personal loans that you borrow against a personal asset like jewelry or electronics. These assets are left at the pawnshop and if your loan is not repaid, they can sell your asset.
Interest rates for these loans can run as high as 200%. However, you don't have to worry about damaging your credit or dealing with debt collectors if you default on your loan; you will simply lose your asset.
Best For: Payday loans are unsecured loans that are repaid in full on your next payday and carry high interest rates.
What are the benefits of a personal loan?
Personal loans can be used for a variety of reasons. Whether you need the funds for an emergency, home improvement, debt consolidation, or a major life event, these loans are flexible enough for any purpose.
Do personal loans affect my credit?
After you submit your application, your credit may take a slight hit -- usually around 5 points due to the initial credit inquiry. (If you make multiple inquiries within a few weeks, it will only count as one.)
Once you receive your personal loan, your credit may be affected due to your new higher debt (unless you are taking out a debt consolidation loan for credit card debt).
However, you can build your credit history by making regular on-time payments on your personal loan.
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