If you have a major expense on the horizon, you may be considering a personal loan. Whether you’re low on funds or you don't want to liquidate your savings, a personal loan can provide a lump sum of money that’s yours to spend as you please — including home improvement projects, medical emergencies, debt consolidation, wedding expenses and more.
The amount you can borrow and the loan's interest rate will depend on several factors, including your credit score, your debt and your income.
How does a personal loan work?
A personal loan is a short-term loan issued by a financial institution to a borrower. Repayment is typically over one to five years. Most personal loans have a fixed interest rate.
With this kind of loan, you make regular monthly payments until you repay the loan in full. As long as the personal loan has a fixed interest rate, you make the same payment each month for the length of the loan term.
When considering a personal loan, you'll want to be sure to distinguish between secured and unsecured loans. Traditionally, personal loans are unsecured, meaning you don’t have to use an asset as security, or collateral, for the debt.
Types of personal loans
There’s a variety of personal loans available, so understanding your options will help you find the one that best meets your needs.
Loans can be secured or unsecured. If you have a less-than-ideal credit score, you may have more success applying for secured loans because they reduce the lender's risk.
- Unsecured personal loans: An unsecured personal loan is a loan not backed by collateral. If you don’t repay the loan, the lender can’t seize any personal assets without going through legal processes to pursue collection.
- Secured personal loan: A secured personal loan is a loan backed by collateral. If you don’t repay the loan, the lender has the right to seize the collateral. Though a mortgage isn’t a personal loan, it is the most easily recognized example of a secured loan. Typical forms of collateral for personal loans are vehicle titles, jewelry and cash savings accounts.
Typical forms of collateral for personal loans are vehicle titles, jewelry and cash savings accounts”
Loans may also come with a variable or fixed rate. It's essential to understand the difference to avoid being surprised if you take out a fixed-rate loan and your monthly payments change.
- Fixed-rate personal loans: With this kind of loan, the borrower pays the same interest rate throughout the life of the loan. These are more typical than variable-rate loans, and they’re helpful for budgeting because your monthly payment never changes.
- Variable-rate personal loans: A variable-rate personal loan’s interest rate can change over time. The interest rate is usually based on an underlying index. Changes in the rate can lead to an unpredictable monthly payment, but some opt for this option to qualify for a lower introductory rate.
Interest on a personal loan
You might expect the interest rates on unsecured loans to be higher than those on secured loans; it’s riskier to the lender when they don’t have the option to seize collateral. However, this isn’t always the case. Lenders tend to market secured loans toward individuals who can’t otherwise qualify for unsecured loans, so you might find that they require collateral and have interest rates similar to unsecured loans.
Pros and cons of a personal loan
Just as with any financial product, there are benefits and drawbacks to consider with a personal loan. Consider the following pros and cons as you decide whether a personal loan is appropriate for your situation.
- Widely available
- Funds can be used for nearly any personal purpose
- Fast approval and funding
- Helps establish and build credit
- Interest rate can be high
- Can result in further debt
- Penalties and fees
- Applying may affect your credit score
What can you use a personal loan for?
One of the most significant benefits of personal loans is that you can use them for nearly any purpose. You might use the funds for:
- Home improvement projects
- Debt consolidation
- Medical emergencies
- Wedding expenses
- Vehicle repair
- Funeral expenses
Personal loans are versatile, but lenders can place restrictions on the use of the funds. You generally can’t use the money for:
- Business expenses
- Illegal activity
- Education expenses
- Real estate purchases
Lenders typically ask for the reason for your loan. Your reason, in some cases, may also affect your interest rate.
Personal Loan FAQs
- What is the average interest rate on a personal loan?
- The average interest rate on a personal loan varies depending on the lender, your credit score and the amount of money you borrow. Rates generally range from 6% to 36%. The average rate on a 24-month personal loan as of August 2021 is 9.39%, according to the Federal Reserve.
- Can you get a personal loan with a credit score of 550?
- It depends on the lender. Some lenders may approve you for a personal loan with a credit score as low as 550. However, your interest rate will likely be very high. In some situations, a lender may issue the loan as long as there is a form of collateral.
- What is a good reason to get a personal loan?
- The best reasons to get a personal loan have the potential to better your overall financial situation. For example, if you get a loan to consolidate high-interest debt, the loan will likely lower your monthly payment and the amount you pay in interest, assuming the rate is lower than for the debts you’re consolidating. It’s also common to use a personal loan for home improvement. It’s only a good idea to get a personal loan if you know you’ll be able to repay the lender.
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