It’s not uncommon to find yourself in a situation where a little extra cash on hand would go a long way. Maybe your car breaks down on the way to work and you need to bring it into the shop for repairs, or maybe a pipe bursts in your house and floods the basement. Whatever it is, we all could do with a financial boost now and again.
Ideally, with enough foresight and planning, your hope is to be able to save up for personal expenses, but that isn’t always going to be possible. When you’re in a pinch, a personal loan may be just what you need to get you through it. Having said that, applying for a personal loan is a big financial decision that you shouldn’t do on a whim. You’ll need to do your research to understand what types of financial products may be available to you, and when one may be better suited to your situation than another.
Today, we’re going to help give you some guidance by going over some common types of personal loans and when you may want to consider applying for one.
What is a Personal Loan?
Broadly speaking, a personal loan is money you borrow to use for some sort of personal expense. You can apply for them with credit unions, banks, other store front lenders, or online lenders. The way the repayment process is formatted varies between different types of personal loans (something we’ll get into more later), but you’ll generally need to repay the amount of money you’ve borrowed along with interest and sometimes fees.
What are the Differences Between Secured and Unsecured Personal Loans?
There are two categories that a personal loan will typically fall into. These are secured and unsecured personal loans. The central difference between the two is the requirements for qualification. The rates and terms are also generally different. Let’s get into these differences in more detail.
Secured Personal Loans
The main defining feature of a secured loan is the fact that in order to qualify, you’ll need to pledge collateral. This means that if you default on your loan, the financial institution can receive some sort of payment by claiming the collateral. This may give them some comfort because even if you aren’t able to make your payments, they may still come away from the interaction with something of value.
What serves as collateral can vary depending on the financial institution and type of loan, but it can be something like your equity in your home, your car, or some other valuable asset. Because collateral ensures that a lender is going to get some sort of payment, secured loans may come with generally favorable rates.
Unsecured Personal Loans
You may have guessed it, but when it comes to unsecured personal loans, there’ll be no collateral involved to qualify you for a loan. Instead, you’ll be evaluated in other ways to make sure that you’re a reliable borrower.
What you need to qualify for a personal loan may vary between different lenders, but there are still some things that most financial institutions will look for. For starters, your credit history may play a big role in determining whether you get approved or denied. It’s meant to show a financial institution that you’ve been reliable in the past when it comes to paying off what you’ve borrowed in a timely manner, amongst other things. They may also look closely at your employment situation, your income, and the state you live in.
You should also keep in mind that while you won’t need to worry about losing an asset if you can’t make your loan payments, unsecured loans tend to come with higher rates than secured loans. This is because a lender has no guarantee that you’ll they’ll get something out of the engagement.
When to Consider Using a Personal Loan
Like we’ve said, when it comes to personal expenses, your best option is always to save up and avoid taking on extra debt. But this won’t always be possible. While personal loans shouldn’t be used lightly, especially when you have the option to save up, they may be a viable option depending on the situation.
There are certain types of personal loans that can only be used for specific things. On the other hand, you may have more freedom to use some types of loans on other things, as you need. They may be useful for things like:
- Purchasing a home
- Buying a car
- Dealing with an unexpected medical expense
- Making an essential home repair
- Fixing your car
3 Different Types of Personal Loans
Now that we’ve established what a personal loan is and when you might want to consider applying for one, it’s time to go over some of the common types of personal loans that are out there. These are generally broad categories of personal loans and there are different types that can fall under the umbrella of each, but when you’re looking for a personal loan, you’ll likely run into one of these.
1. Installment Loans
Installment loans are one of the most common types of personal loans out there. If you’re approved for one, you’ll be given a lump sum that you’ll need to pay back (along with interest and/or fees) over a series of scheduled payments. The term of your loan (how long your repayment period will be) will vary depending on the financial institution, the type of installment loan, and certain other factors, but it can span anywhere from a few months to several years.
Your payments will generally be scheduled in equal amounts and the dates and amounts due will be laid out ahead of time. This may make it easier for you to work these payments into your normal budget, and the spread out nature of the payments may be easier for you to manage than if you had to pay back what you owe by your next pay date.
2. A Personal Line of Credit
A personal line of credit (LOC) functions differently than a more traditional installment loan. One of the main differences is that it’s a form of revolving credit. What this means is that instead of being given a lump sum, you’ll instead be authorized for a specific credit limit. You can draw money against this limit assuming your account is in good standing and you have available credit.
Lines of credit may be flexible in that you can choose when and how much money you’d like to borrow, assuming it falls within your limit. On top of that, you won’t be charged on the total amount of your line of credit, but instead will only be charged interest and/or fees on the amount you’ve drawn.
Want to learn more about the differences between lines of credit and installment loans? Click here!
3. Credit Cards
There’s a lot of overlap between personal lines of credit and credit cards. Firstly, they’re both a form of revolving credit. This means that with a credit card, you’ll be given a credit limit just as you would with an LOC. And just like a line of credit, you’ll only be paying interest/and or fees on what you’ve borrowed. You’ll also have the choice to make a minimum payment each month if you’re not able to make your full payment but want to make sure your account stays in good standing. Just remember that the longer you put off paying your credit card in full, the more the interest will build up.
Credit cards may be a good option for everyday, small purchases. Because they often come with rewards like cash back and travel rewards, making purchases on your credit card and then paying these down right away is a good way to take advantage of their benefits. Just keep in mind that you should never buy things on your credit card without having the money to pay them back immediately.
Want to learn more about the differences between lines of credit and credit cards? Click here!
Other Types of Personal Loans
Like we mentioned, the personal loans on the list above are broad categories under which many other types of loans fall into. You might find that over the course of your life, you’ll end up in a situation where you’d be best served by a personal loan that’s intended for a more specific use. Let’s take a look at some of these options a little more closely.
Mortgages
If you’ve ever bought a home, there’s a good chance you already know what these are. A mortgage is a secured personal installment loan that’s specifically designed to help you purchase a home. The collateral you’re putting up in this case is the home you’re purchasing.
When buying a home, you’ll generally need to make an initial down payment. The remainder of what you owe will be paid off by your mortgage, which you’ll then need to repay over a fairly lengthy term.
Student Loans
Student loans are personal loans that are intended to help you fund your education and are typically given out by the government. They may be subsidized by the government and will often come with relatively low rates. On top of that, you often won’t need to start paying them off until you’ve graduated.
Home Equity Lines of Credit (HELOC)
A HELOC is a secured line of credit, where the collateral you’ll need to put up is the equity you have in your home. They can be a flexible financial safety net when you’re undergoing a large-scale home improvement project but don’t know exactly how much it’ll cost.
Auto Loans
An auto loan is an installment loan that is designed to help you purchase a vehicle. You’ll generally need to secure these loans by putting up the car you’re buying as collateral.
Educate Yourself on your Personal Loan Options
As we can see, there are plenty of different types of personal loans out there to help you in a whole host of situations. When you’re in the dark about what your potential options are, it can be tough to make an informed decision. And any time you’re making a choice that is going to impact your finances, you’re going to want to be especially careful.
Before you apply for a personal loan, do your research and educate yourself on what your potential options may be and try to find something that fits your particular situation. Be patient and don’t make any rash decisions. If you’re looking for more information on personal loans, check out our blog for more useful personal finance tips!
Disclaimer: This article provides general information only and does not constitute financial, legal or other professional advice. For full details, see CreditFresh’s Terms of Use.
