A Quick Guide To Different Types Of Personal Loans

Most personal loans offer a fixed interest rate and minimum borrowing amount of around $1,000 to $2,000 – an attractive solution for debt consolidation, paying for home improvement projects or building credit.

Various types of personal loans are available, including some that allow you to immediately fund your plans without risking collateral like you would with a home equity loan. Let’s break down the different types of personal loans so you can make the right choice for your circumstances.

Types Of Personal Loans

It’s helpful to think about unsecured, secured, fixed-rate and adjustable-rate loans as umbrella terms. You can categorize the different types of personal loans you’ve probably heard of – home improvement, debt consolidation, vacation loans, etc. – into one or more of these terms. Let’s break it down.

Unsecured Personal Loans

An unsecured loan is the most common type of personal loan you’ll encounter. Unsecured loans are personal loans backed by your credit profile rather than collateral, such as real estate, a car or a pawn shop item. You’ll pay this loan back in fixed installments, typically over the course of 1 – 6 years.

Unsecured personal loans are best for people with an excellent credit score. Borrowers with a bad credit score may face an interest rate as high as one they’d find with a credit card.

Here are some advantages and disadvantages of unsecured personal loans, broken down in this simple table:

Secured Personal Loans

Now for secured personal loans, which are backed by collateral that the lender can repossess if you default on the loan payments. Common types of collateral include real estate, cars, boats, RVs, savings accounts and certificates of deposit (CDs). Secured loans are good options for borrowers who are certain they’ll be able to pay the loan back. That’s because the collateral unlocks a lower interest rate since the loan is less risky for the lender.

The most significant consideration for secured loans is the risk of losing your property. Here’s a more simplified breakdown of the pros and cons.

Fixed-Rate Personal Loans

Personal loans can come with either a fixed or variable interest rate. Most often, lenders offer personal loans with a fixed rate. This means the interest and monthly payment will remain unchanged until the loan is paid in full.

Fixed-rate loans allow you to stay on budget since your monthly payments won’t fluctuate. Here’s a closer look.

Adjustable-Rate Personal Loans

On the other hand, adjustable-rate loans can change from month to month based on what’s called a benchmark rate. As your interest rate changes, so do your monthly payments.

Because interest rates tend to gradually increase or decrease over extended periods of time, variable-rate options potentially make more sense for short-term loans if you can lock in a lower rate for a period of time.

Personal Loan Categories

Now that you know about the different types of personal loans, we can delve into more commonly referenced personal loan categories.

Debt Consolidation Loan

Most major lenders offer debt consolidation loans, which allow you to combine credit card balances, medical bills, auto loans and other debt into a single payment.

This option is a great way to swap out high credit card interest rates for a lower interest rate. It also makes debt more manageable since you can make a single payment each month.

Co-Signed Loan

If a borrower has yet to build good credit or if they have bad credit, a co-signed loan is likely the best option for them. A co-signer – usually a relative or close friend of the primary borrower – takes on the legal responsibility of paying off a loan if the borrower defaults. They risk their own savings or credit to help the primary borrower get approved for the loan.

Whether it’s wise to co-sign on a loan will depend on the reason for the personal loan, the primary borrower’s credibility and the co-signer’s financial stability. Rocket Loans^SM doesn’t currently offer the option to co-sign on loans.

Credit Builder Loan

Credit builder loans are a great way to build credit without a credit card and avoid co-signers altogether. More commonly found at smaller banks or credit unions, credit builder loans have relatively small balances ($500 or $1,000).

Typically, the borrower secures the loan with a savings account or CD, which will be inaccessible to the borrower until the loan is paid off. The loan is often so small that it’s paid in full within a few months. With each fixed, on-time payment, the borrower’s credit improves. Once the loan is paid off, you’ll have access to your collateral again, along with all the financial opportunities that improved credit offers.

Home Improvement Loan

A personal loan for home improvements is an excellent choice for property owners who want unsecured financing. Unlike a home equity loan or home equity line of credit (HELOC), an unsecured personal loan won’t use your house as collateral. This means if you default on your payments, the lender won’t foreclose on your property.

However, depending on your credit score, an unsecured personal loan may have a higher interest rate than a home equity loan, since it doesn’t use collateral. You also might have a shorter loan term, meaning your monthly payments will likely be higher.

Common Types Of Personal Loan Alternatives

Personal Line Of Credit

While personal loans offer access to a one-time lump sum, personal lines of credit are more flexible. Most major banks offer personal lines of credit, for which you can be approved for up to a certain amount. You only pay interest on the money you’ve borrowed.

This borrowing option is good for evolving circumstances like ongoing medical expenses and home improvement projects without a set budget, or even an inconsistent income. While lines of credit operate similar to credit cards, they’re likely to have a lower interest rate based on your credit, though not as low as the rate on a traditional personal loan.

Point-Of-Sale Loan

Point-of-sale loans, often called “buy now” loans, “pay later” loans or BNPL, are a type of financing that allows you to purchase an item on credit and pay it back in smaller installments over a short time period. This option is similar to the more traditional layaway method common with many big box retailers.

BNPL services have become more popular in recent years as consumers wish to pay for large purchases over a span of months. BNPL loans come with fees, however, and your credit score could be impacted negatively if you don’t make your payments.

Credit Card Cash Advance

Some credit cards allow you to take out a cash advance against your available balance, but they often come with an even higher interest rate than when you swipe your card. However, you don’t need to submit an application or go through a credit check to receive the funds, making a cash advance an attractive option for borrowers who need one for an emergency.

Just keep in mind: If you have a credit card, you likely have good enough credit to qualify for an unsecured personal loan, which will have a more competitive interest rate than a credit card cash advance.

Types Of Personal Loan Alternatives To Avoid

The greatest drawing card of personal loans and their alternatives can also be their greatest drawback. Quite simply, it’s the fact that they’re personal. In other words, lenders aren’t appraising the return on investment like they would in the highly regulated mortgage industry.

The predatory lending practices used with some of the financing options described below are setting the stage for increased regulation:

• Payday loans: This type of loan is usually unsecured and comes with an extremely high interest rate and short repayment period. Payday loans also use exorbitant fees, which can further complicate the borrower’s financial situation.
• Pawn shop loans: Pawn shop loans are another alternative that can create issues for a borrower. To use this type of financing, you’ll have to offer up a valuable item as collateral.
• Wedding loans: As the name suggests, wedding loans can cover the costs of your big day, but they also make it easy to overspend on unnecessary extras.
• Vacation loans: Some financial experts advise against taking out a loan for leisure travel since you could end up paying more than expected once you add in your interest payments and fees.

FAQs About Different Types Of Loans

To help you make your decision, we’ve answered a few of the most frequently asked questions about the different types of personal loans.

Which type of loan has the highest interest rate?

Without question, of the loans described above, payday loans typically come with the highest interest rate. Payday loans have such elevated interest rates that there’s an entire movement set out to regulate the industry.

In fact, 19 states plus Washington, D.C. have passed legislation limiting a payday loan’s APR to no more than 36%. However, a much higher number of states – 45 – have placed at least some type of cap on a payday loan’s APR.

Only Delaware, Missouri, Idaho, Utah and Wisconsin haven’t set a specific rate cap for lenders.

Which type of loan has the lowest interest rate?

A secured personal loan is most likely to have the lowest interest rate, but that doesn’t mean it’s your best option. To unlock this low rate, you must back the loan with a type of collateral like your savings account, a CD, a vehicle, a boat or even a house. Secured personal loans are only good if you’re so certain you can repay the loan that you’re willing to risk your property.

Which personal loan type will affect my credit score?

No matter which type you use, a personal loan can affect your credit score in a few ways. First, when you apply for financing, the lender will make a hard inquiry when they pull your credit report, and this can drop your credit score by up to five points.

A personal loan can also affect your credit history if you miss payments or make late payments, both of which can reduce your creditworthiness in the eyes of lenders. That’s why it’s crucial to make sure you can afford the monthly payments on an installment loan before applying for one.

What fees can I expect for any type of personal loan?

Unlike other forms of financing, personal loans don’t require a lot of fees. However, most traditional banks, credit unions and online lenders charge origination fees to cover the administrative costs of the loan. You can also expect a late fee if you miss a payment, and you might incur a prepayment penalty if you pay off the loan ahead of schedule.

Final Thoughts

While terms like “construction loan” and “medical loan” reveal the purpose of the borrowed sum, it’s more important to understand the terms of your personal loan.

Be sure to shop around for the best rate, read the fine print and make the wisest decision for your financial future. If you’re ready to take the next step, apply for a personal loan with Rocket Loans today.