Have you ever been in a situation where you are just short of cash? It can happen to anyone. Even if you planned your finance carefully, unexpected expenses could emerge.
Personal loans can be a lifesaver in such a scenario. They can help you alleviate your financial pain and be your partner in tough times.
This is one of the reasons for the rapidly growing popularity of personal loans. In fact, just in 4 years, from 2015 to 2019, the value locked in personal loan balances has almost doubled, climbing up to $143 billion in the US alone.
Personal loans have become famous amongst individuals of various backgrounds and income levels, and that is not a local, but rather a worldwide tendency. People usually use personal loans to cover current expenses, pay for their home repairs and improvements, or pay off other debt they have, like credit card balances.
The amount of money you can get from a lender varies from a couple of hundreds to tens of thousands, depending on various factors like your credit score and your income levels. In most cases, personal loans have between 1 to 5 years repayment period.
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Here, we will examine what are the available types of personal loans out there as well as some major determinants which help you choose the one that best suits your needs.
Types of Personal Loans
There are two most common types of personal loans that go hand in hand with the two usual ways of applying interest to your loan. Let’s take a look at them.
#1. Unsecured Personal Loans
This is the type of personal loan that is preferred by most. Lenders fund you without demanding any collateral. They do it mostly based on your credit score. So good credit history is a benefit in terms of getting easy approval and good rates.
However, since the risk for lenders is higher with unsecured loans, the interest rates could be higher as well, compared to the next type of personal loan.
#2. Secured Personal Loans
If you want to take out a secured personal loan, you need to provide collateral to the lender. It can be in the form of your savings, your car, or any other valuable asset you possess.
If you fail to repay the loan, the lender can claim your asset and sell it to cover the outstanding debt amount. This is the reason you need to be sure you can keep up with your installments.
Otherwise, you take the high risk of losing your collateral. The good news is you are compensated by a lower interest rate that lenders impose on your loan.
Fixed-Rate vs. Variable Rate Loans
The majority of personal loans are with a fixed rate, meaning the monthly payments will remain the same for the whole repayment period. A variable-rate loan has a fluctuating interest rate throughout the life of the loan, depending on a benchmark set by commercial and central banks.
Fixed-rate loans make your budgeting a lot easier. Also, they protect you against the event of rising interest rates. Considering interest rates level have been record-low for a long period of time, a surge in interest rates won’t be much of a surprise.
On the other hand, a variable-rate loan has a lower initial APR compared to a fixed-rate loan, but the interest can rise (or decrease) in time. It is a great option if you plan to repay your loan in a short period of time, and usually, variable interest loans have no prepayment penalties.
In most cases, there is a cap on the interest level change for specific periods of the loan so it is not impossible to carry out your plan of early repayment. Just ask your provider for how long they guarantee this rate, let’s say six or twelve months.
Other popular types of loans include:
– Co-sign Loans: Generally for people with little or no credit history who are not eligible to take out a loan by themselves. The co-signer is the person who is held responsible if the original borrower defaults.
– Debt Consolidation Loans: They combine all your current loans into a single one. This simplifies your debt management by having to pay only one installment with the added bonus of a lower APR (usually).
– Payday Loans: They are unsecured, risky, and short-term loans that have high-interest rates. Also, this type of loan needs to be repaid in full on the next ‘’payday’’ indicated by the lender. Generally, payday loans are not recommended, and many experts advise to refrain from getting such loans.
So how to make the right decision for your personal loan?
Whether you decide to take out a loan from a bank, an online lender, a credit union, or even a P2P lending platform it is wise to follow these 3 simple rules to find the best option for you:
1. Compare Different Interest Rates
It is not uncommon for different financial institutions to give the same individual different interest rates on their loan. Of course, all will claim they have the best offer.
Because of that, it is always wise to do your own research. You can either check this by going to the websites of various providers or contact them directly to get an offer.
Comparison websites, like NerdWallet, are also a great tool to achieve that.
2. Figure Out Fees and Charges
Sadly, except for the interest rate, there are also other expenses related to your personal loan. They could be in the form of origination fees, loan cancellation charges, late payment charges, etc.
The inescapable one is usually the origination fee, which is revolving around 2.5% in most cases. Bear in mind that the processing fee should be included when calculating your APR.
As we already mentioned, lenders charge small fees for paying your loan upfront. This again depends on the conditions and the type of your personal loan, but the usual amount of the charge is between 2 to 5% of the remaining balance.
So be sure to carefully review the terms of your contract before signing the papers to cash out. Thus you will have the opportunity to save some money on interest if you manage to repay your loan sooner than expected – a deserved reward for the great job you did.
So there you have it!
There is nothing wrong with taking out a personal loan. There is something wrong, however, if you are not getting the best option available.
Knowing what are the main types of loans and how you can choose the right one from the get-go will allow you to have financial security in tough times while not having to break the bank.