Types of personal loans and how they work

Different types of personal loans

Each type of personal loan has advantages and disadvantages. Your unique situation will help you decide which one is right for you.

Secured personal loan

A secured loan – as the name suggests – secures the loan for the lender through collateral. If you are unable to repay your loan, the terms of a secured loan allow your lender to take possession of the collateral as payment.

Although secured personal loans require borrowers to risk an asset as collateral, borrowers can access reduced interest rates this way. In addition, secured personal loans allow borrowers whose bad credit would otherwise prevent them from going into debt to obtain a loan.

Unsecured personal loan

Unsecured Personal Loans are more typical than secure. Borrowers with sufficient credit (usually 600 or more) can access unsecured personal loans. Your credit score will determine how much your lender is willing to lend you. Also, the better your credit score, the lower the interest rate you can get from your lender. However, unsecured personal loans rarely have an interest rate as low as secured loans.

Fixed-rate and adjustable-rate loans

Personal loan interest rates are of two types: fixed rate and adjustable rate.

Fixed rate loans have an interest rate that never changes. The permanent rate allows borrowers to always make the same monthly payment and not worry about a variable rate causing their monthly payment to rise unexpectedly. However, fixed interest rates are probably not as low as adjustable interest rates.

Adjustable rate loans (sometimes called floating rate loans) offer borrowers an initiation period with an interest rate that is often lower than a fixed rate loan. After the initial term expires, the interest rate adjusts and changes based on trends in the broader loan market. Predefined caps and floors govern how much your interest rate increases or decreases.

Adjustable rate loans are great for borrowers who can pay off the loan before the introductory interest rate expires. However, borrowers who plan to carry the debt of the loan over its entire term may find a fixed rate loan more advantageous, as it is not subject to rising interest rates.

debt consolidation loan

Debt Consolidation Loans are a popular option for borrowers facing multiple debilitating debts. Ideally, debt consolidation loans allow you to consolidate all your debts into one account that charges less interest than the original debts.

For example, they are often useful for credit card debt and student loans. By making one affordable monthly payment, you can effectively settle your debt and avoid paying multiple debts with high interest rates.

However, debt consolidation loans are only beneficial if they save you money. Therefore, it is recommended that you confirm with your lender what interest rate they will charge you, whether the rate is fixed or variable, and what your monthly payment will be. Plus, debt consolidation loans cost origination fees, like most other loans, so taking out a loan without doing your homework could be a costly mistake.

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