Personal Loans: What You Need To Know
We all get into situations where we might need a little money in trouble. A personal loan can help you improve your finances and help you through difficult times. Lenders offer personal loans from a few hundred dollars to thousands of dollars. You generally have between one and five years to pay.
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 is 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 you to provide some form of collateral to the lender, whereas an unsecured loan requires none.
Guaranteed personal loans
By obtaining a secured personal loan, you can give your lender access to your savings account or secure the loan with a valuable item. Banks often require a savings account or CD, while pawn shops can be sources of loans secured with a variety of valuables. Some lenders accept boats and RVs as collateral, and auto-backed loans are common. If you do not repay the loan, the lender can keep your property.
Pros
- Potentially lower rates, because the security reduces risk to the lender.
- Potentially higher loan amounts, depending on collateral value.
Cons
- If you can’t repay the loan, you could lose your collateral.
It is especially important to be careful with secured loans offered by payday lenders and auto title lenders. These are exceptions to the idea that you will pay a lower rate due to the warranty provided. In contrast, a payday loan secured by your next paycheck or a car title loan secured by your car often carries high fees and skyrocketing interest rates.
Unsecured personal loans
Instead of demanding collateral, unsecured lenders 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 will have a lower rate. You can still get a bad credit unsecured loan, but you will have to pay a much higher rate to offset the risk taken by the lender.
Pros
- 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.
Cons
- 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 almost anything you want. In fact, you've probably heard of credit building loans, vacation loans, wedding loans, or even funeral loans. Before deciding on a loan, analyze the situation and determine if it makes sense to you.
Loans for credit builders
These are loans designed to help you rebuild your credit or help you get credit for the first time. They may be secured by a savings account or may even be uninsured, depending on the lender and the terms. As you make payments on time, your credit score improves, opening you up to other financial opportunities and savings.
Many credit building loans have relatively small balances and can be repaid in a few months. However, if your loan is secured, it is important to know that defaulting on payments could result in the loss of your collateral.
Vacation Loans
Vacation loans are generally unsecured. You can get one of these loans to take a trip and see new things. However, the downside is that you can now spend several months, or even years, paying. Even if the memories fade, the debt still exists. An alternative to getting a vacation loan is to plan ahead and save for the trip. Find out how much you need to save each month to reach your goal and not have to worry about paying interest.
Wedding Loans
Like vacation loans, they are generally unsecured and have a specific purpose. Weddings can be expensive and finding money for one can be difficult. A loan can help pave the way, especially if you have good credit and can get a low interest rate. You can reduce the loan amount by modifying your plans or saving as much as you can and borrowing only 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 interest, you will save money and get out of debt sooner. Another advantage of a debt consolidation loan is that you can use it to pay off credit cards, which can affect your credit utilization score.
However, be careful with debt consolidation loans because by freeing up space on your credit card, you may be tempted to use it again, which may put you in a worse position down the road.
The bottom line
A personal loan can help you get the money you need for a variety of purposes. However, whenever you borrow money, be careful. Borrow only what you need and try to pay off the debt as quickly as possible to reduce what you pay in interest.
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Source: MoneyCoach
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