Personal loans are a good way to receive much-needed cash and pay it back over time, but not all loan types are the same. Loans vary based on how the funds can be used, whether collateral is required and interest rates. Understanding the various types of loans is crucial to deciding which will work best for your situation.
7 most common types of personal loans
When shopping for a personal loan, you'll probably notice a few loan types that appear repeatedly. Here are the seven most common types of personal loans and who may benefit from each loan type.
- Unsecured loans: Lenders don't require collateral for unsecured loans. This means that if you fail to repay the loan, you won’t have to surrender an asset, such as a car or savings in a bank account.
- Secured loans: Lenders require collateral for a secured loan. Auto title loans require you to provide the title of the vehicle as collateral. If you don’t make payments on time, the lender can legally repossess the vehicle to recover the money it's owed. A mortgage is another type of secured personal loan that uses your house as collateral.
- Fixed-rate personal loans: With a fixed-rate personal loan, your payments remain the same from one month to the next throughout the loan term. This type of loan is good for those who prefer predictable payments.
- Adjustable-rate personal loans: Interest with an adjustable-rate personal loan may change according to market conditions. If your interest rate goes up, your monthly payments increase as well. Adjustable-rate loans may have a lower introductory interest rate than fixed-rate loans, making them ideal for borrowers who plan to pay off the loan early before the interest rate can go up.
- Co-signed loans: If you can't qualify for a loan on your own, the lender may require a co-signer. When someone co-signs your loan, they bear equal legal responsibility for the debt. If you fail to make payments on time, the lender reports negative activity, lowering your credit score as well as your co-signer's credit score. If you default on the loan, the lender can hold your co-signer responsible for the debt.
- Debt consolidation loans: If you have several high-interest debts, you may be able to pay them off using a single debt consolidation loan. This type of personal loan lets you make a single payment each month at a (hopefully) lower interest rate.
- Personal lines of credit: With a personal line of credit, a lender gives you access to a certain amount of money that you can borrow over time. You pay interest only on the amount of money you've borrowed. A personal line of credit may work well if you need to fund an ongoing project, such as a major home remodel.
Which type of loan is right for you?
The type of loan that’s best for your situation depends on a few factors, including your credit status, your reason for getting the loan and potential loan terms.
Many lenders have minimum FICO credit score requirements. Credit scores in the 670 to 739 range, which fall into the "good" category, may be necessary to qualify for a low annual percentage rate (APR).
Lenders may also require you to show you have steady employment and can make the personal loan payments before approving your loan application. Before you apply for a personal loan, it's smart to check your credit history so you can identify and correct any mistakes that might be affecting your credit scores. An informal study by Consumer Reports concluded one-third of volunteers looking at their credit reports found errors.
You can get a free copy of each of your three credit reports from Experian, Equifax and TransUnion at www.AnnualCreditReport.com. If you find accounts you don't recognize or a creditor has reported incorrect information, you can ask the credit bureau to investigate the report. If the reporting lender can't verify the information, they must remove it from your credit report, which may help increase your credit score.
Purpose of the loan
Certain personal loans work better for specific goals. For example, if you want to pay off a few debts with high interest rates and unfavorable terms, a debt consolidation loan with a lower interest rate and predictable monthly payments may meet your needs. If you want to buy a classic car to fix up and sell, a personal loan with a variable interest rate may fit the situation.
Before accepting a loan offer, familiarize yourself with the terms to make sure they work for your financial situation. Your loan terms provide details about your interest rate, any fees you must pay, the amount and due date of your monthly payments and the number of months you'll make payments. If the loan terms aren't what you expected, you can reject the loan offer before signing the paperwork.
- Where can you get a personal loan?
- When shopping for a personal loan, check with your bank or credit union. It may provide low-interest and unadvertised loans to current customers and members. You can also turn to online lenders, which may offer competitive loan terms.
- What are some personal loan alternatives?
- If you have problems qualifying for a personal loan, you may be able to finance your purchase with a credit card. While credit cards typically have a minimum payment, you can (and should) make a monthly payment larger than that to reduce the amount of interest you pay on the debt.
If you qualify for a credit card with a temporary 0% interest rate and commit to paying off the debt before the introductory period is over, a credit card may work better than a personal loan. If your purchase isn't urgent, saving money over time and paying cash lets you avoid paying fees and interest.
While it may be tempting to turn to a payday lender (in states where this type of loan is legal), payday loans are notorious for trapping borrowers in a cycle of high-interest debt. Before you go to a payday lender, find out if your bank offers any alternatives. Many credit unions and banks now offer short-term loans to help with emergency expenses so their customers aren’t exposed to the financial harm often caused by payday loans.
- What credit score do you need to get a personal loan?
- Each lender sets its own approval criteria for personal loans. In general, borrowers with higher credit scores have access to loans with lower interest rates and better terms.
FICO credit scores above 670 are "good," according to Experian, but many lenders grant loans to applicants with credit scores as low as 600. Subprime lenders that specialize in loans for people with bad credit may charge high fees and the highest interest rates legally allowed, so proceed with caution if you need a subprime loan.
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