Whatever you may need it for—from buying a car to covering an emergency expense—personal loans can provide funds when you need them most. However, if this is your first personal loan, you ought to know the four main types of personal loans, as well as their pros and cons.
How Personal Loans Work
Personal loans can be used for just about any purpose. You can take a personal loan of anywhere from a few hundred dollars to thousands of dollars. Different lenders have different eligibility criteria for the approval of personal loans. These criteria are generally quite easy to meet.
When applying for the personal loan, you may be required to state what you need the funds for. However, the purpose of the funds rarely has a bearing on whether or not you get approved. Being approved depends majorly on how the lender assesses your risk.
Once approved, lenders rarely place restrictions regarding what you can spend the funds on. In most cases, you will have between one and five years to repay the loan.
Types of Personal Loans
There are 4 main types of personal loans available, each of which has their own pros and cons.
1. Unsecured Personal Loans
Unsecured personal loans are offered without any collateral. Lenders approve unsecured personal loans based on your credit score. A good credit score will make it easier to get approved. Because there is no collateral involved, these loans are riskier for lenders. They offset this high risk by imposing higher interest rates on unsecured loans.
Pro: You don’t have to put up your home or car as collateral.
Con: You pay a slightly higher rate of interest on the loan.
2. Secured Personal Loans
Secured personal loans are backed by collateral. Lenders offer unsecured personal loans against your vehicle, personal savings, or any other valuable asset. If you default on your loan, the lender can seize whatever asset you’ve put up as collateral. Because the risk is lower, you will a lower interest rate on these loans.
Pros: Potentially lower rate of interest. Depending on the value of the collateral, you may also get approved for a larger loan.
Cons: You could lose your collateral if you do not repay the loan on time.
3. Fixed-Rate Loans
With fixed-rate loans, your interest rate and monthly payments stay the same throughout the life of the loan.
Pros: Consistent monthly payments make it easier to make and stick to a monthly budget. Also, rising interest rates won’t affect you.
Cons: You won’t benefit in the rare event that interest rates fall.
4. Variable-Rate Loans
With variable rate loans, the interest rate can rise or fall depending on prevailing market conditions. However, there is usually a cap on how much the rate can change over a specified period of time. These loans usually have a lower APR as compared to fixed-rate loans. Variable-rate loans
Pros: Lower APR as compared to fixed-rate loans. You may benefit if overall market interest rates drop.
Cons: The interest rates and monthly payments fluctuate frequently, making it difficult to set a budget. You may pay a higher rate if market interest rates rise.
Finding the Right Personal Loan
The key is to find a loan that works for you. Understanding the features of the different types of personal loans and the pros and cons of each can help you choose one that’s right for you.