We all get in situations where we might need a bit of money in a pinch. A personal loan can help smooth your finances and get you through a tough time. Lenders offer personal loans of anywhere from a couple hundred dollars to thousands of dollars. You usually have between one and five years to repay.
There are different types of personal loans, and understanding them and how they work can help you make the right decision for your finances. Here’s what you need to know.
Secured and Unsecured Personal Loans
There are two main types of personal loans: secured and unsecured. A secured personal loan requires that you provide some type of collateral to the lender, while an unsecured loan doesn’t require any.
Secured Personal Loans
When you get a secured personal loan, you might provide your lender with access to your savings account, or secure the loan with a valuable item. Banks often require a savings account or CD, while pawnshops can be sources of secured loans with a variety of valuable items. Some lenders will accept boats and RVs as collateral, and loans secured with autos are common. If you don’t repay your loan, the lender can keep your property.
Potentially lower rates, because the security reduces risk to the lender.
Potentially higher loan amounts, depending on collateral value.
If you can’t repay the loan, you could lose your collateral.
It’s especially important to be wary of secured loans offered by payday lenders and car title lenders. These are exceptions to the idea that you’ll pay a lower rate because of the collateral you provide. Instead, a payday loan secured by your next paycheck or a car title loan secured by your car often carries high fees and sky-high interest rates.
Unsecured Personal Loans
Rather than requiring collateral, lenders making unsecured loans rely on your credit score to make a decision about how much you can borrow and the rate you’ll pay. If you have good credit, you’ll end up with a lower rate. You can still get an unsecured loan with bad credit, but you’ll have to pay a much higher rate to offset the risk the lender takes on.
You’re not putting up anything of value as collateral, so the risk to you is lower.
In many cases, your payments and interest are predictable, so you know exactly when you’ll be done paying the loan.
If you have good credit, you’ll be rewarded with more favorable terms.
You might be limited in how much you can borrow.
It can be harder to get a good rate if you have poor credit.
Types of Personal Loans and Their Uses
A personal loan can be used for just about anything you want. In fact, you’ve probably heard about credit-builder loans, vacation loans, wedding loans, or maybe even funeral loans. Before you decide to get a loan, review the situation and determine whether it makes sense for you.
Credit Builder Loans
These are loans designed to help you rebuild your credit or help you gain credit for the first time. They might be secured with a savings account, or they might even be unsecured, depending on the lender and the terms. As you make timely payments, your credit score improves, opening you up to other financial opportunities and savings.
Many credit-builder loans have relatively small balances and can be paid off over the course of a few months. If your loan is secured, however, it’s important to be aware that stopping payments can result in losing your collateral.
In general, vacation loans are unsecured. You can get one of these loans to go on a trip and see new things. However, the downside is that now you might spend several months—or even years—repaying it. Even as the memories fade, the debt is still there. One alternative to getting a vacation loan is to plan ahead of time and save up for your trip. Figure out how much you'll need to save each month to reach your goal, then you won’t have to worry about paying interest.
Like vacation loans, these are generally unsecured and meant for a specific purpose. Weddings can be expensive, and coming up with the the cash for one can be tough. A loan can help smooth the way, especially if you have good credit and can get a low interest rate. You can reduce the amount you need to borrow by modifying your plans or by saving up as much as you can and only borrowing a small amount.
Debt Consolidation Loans
If you have other debt, you can use a loan to consolidate it in one place, making it easier to manage and pay off. In many cases, a debt consolidation loan is an unsecured personal loan. If you can pay less in interest, you’ll save money and get out of debt sooner. Another advantage to a debt consolidation loan is that you can use it to pay off credit cards, which can your credit utilization score.
You do have to be careful with debt consolidation loans, though, because when you free up space on a credit card, you might be tempted to use it again, which could put you in a worse position down the road.
The Bottom Line
A personal loan can help you get the money you need for different purposes. However, anytime you borrow money, you need to be careful. Only borrow what you need, and try to pay off the debt as quickly as possible to reduce what you'll pay in interest.