Personal loans can help cover you in the case of an unexpected or large expense, such as medical bills or a wedding. Personal loans can also be used to consolidate your debt and pay off high-interest credit cards or make home repairs.
There are different types of loans with various interest rates and rules. The type of interest rate you can secure is mostly based on factors such as your credit score and how much time you need to pay back the loan. The higher your score, the lower your interest rate may be.
We’ll cover four types of loans and what you need to understand about each:
There are pros and cons to each kind of loan, so it’s important to understand the details so you know what to expect and can make an informed decision when you’re ready to move forward.
Pros and cons: Unsecured personal loans
- Pro: You don’t need to use your home or car as collateral.
- Con: You may pay a slightly higher rate of interest.
When a personal loan is unsecured, it means it doesn’t need to be backed by collateral from you, the borrower. This means the lender can’t take away your house or car in the event that you can’t pay back the loan.
Unsecured personal loans can range from $1,000 to $50,000 or more, depending on your credit score and financial history. The term, or length of time that is required to pay back the loan, may vary from one to six years or even be longer.
Interest rates also depend on your credit score. One thing to note is that because unsecured loans aren’t backed by collateral, they are considered riskier for lenders. This means interest rates on unsecured loans may be higher.
Pros and cons: Secured personal loans
- Pro: Potentially lower interest rate, which may depend on the value of the collateral.
- Con: You’ll lose your collateral if you can’t repay the loan.
The opposite of an unsecured loan is a secured loan, which is backed by collateral—your car, house, savings account, or other assets. If you default on the loan, the lender can take your collateral to cover their losses.
Because there is collateral involved, secured personal loans are considered to be less risky for lenders and may result in a lower interest rate for you. Also, because it’s less risky, lenders may have more flexibility for those with less than stellar credit.
The rise and fall of interest rates
Both fixed and variable rate loans are tied to the index rate, which is a benchmark set by banks. These rates tend to fluctuate, which will impact the rate on your loan.
Pros and cons: Fixed-rate loans
- Pro: Predictability in future payments, knowing the Interest rate will never change.
- Con: Potentially higher payments because of a higher interest rate.
Fixed-rate loans have interest rates that will not change over the life of the loan. Examples of fixed-rate loans are personal loans, student loans, and auto loans.
The predictability of fixed-rate loans makes it more simple for people who are budget-conscious or want stability in knowing how much their bills are each month. Also, rising interest rates won’t have any impact on the loan. Conversely, if interest rates happen to fall, you won’t benefit either.
Fixed-rate loans may come with higher interest rates.
Pros and cons: Variable-rate loans
- Pro: A potentially lower interest rate, which means you’d pay less in interest over the life of the loan.
- Con: If interest rates rise, your loan suddenly will become more expensive.
Variable interest rate loans move in tandem with the index rate, which means if it goes up or down, so does your interest rate.
Variable-rate loans may appeal to you if you’re looking for a short-term loan, a shorter time frame could work since the index rate likely won’t fluctuate all that much. A large loan that needs to be repaid over decades may be safer to choose a fixed-rate loan.
An example of when a borrower may have to take on a variable-rate loan is when refinancing a student loan.
The right personal loan
When choosing the right loan for you, think through what’s most important. Is it to pay less in interest over the life of the loan? How long do you expect to take to pay back the loan?
Lay out the circumstances of why you need a loan and how quickly you can pay it off. Then you can choose the loan that makes the most sense for you.