Personal loans can be used for just about anything, and although when you’re applying for one, you may be asked what the loan will be used for, this rarely has any bearing whether or not you’re approved. Being approved or not depends on how the lender assesses your risk. Once approved, you can use the funds immediately for whatever you like, and you usually have between one to five years to repay the loan.
Choosing which type of personal loan is right for you can be tricky, but here, we’ll help you make the best decision.
Unsecured Personal Loans
Lenders approve unsecured personal loans based off your credit score, and you don’t have to put up any collateral. Of course, a better credit score increases your chance of approval, as these loans are riskier for lenders since there is no collateral. Unsecured personal loans have higher interest rates because of the risk.
Unsecured loans are based only on your promise to pay and are not secured by any property that can be foreclosed or repossessed to pay the loan. Credit cards are examples of unsecured loans. Unsecured loans usually have a higher interest rate because they carry more risk for the lender.
Secured Personal Loans
Secured personal loans are backed by collateral, such as your car, savings, or any other valuable asset. The lender can seize whatever you use as collateral if you do not pay the loan back on time. But, a lower risk for the lender means a lower interest rate for you. Plus, depending on the value of your collateral, you may get approved for a larger amount.
As the name suggests, with a fixed-rate loan, your interest rate and monthly payments stay the same throughout the life of the loan. Having consistent monthly payments makes it easier to stick to a budget, and rising interest rates won’t affect you. Of course, this also means that if interest rates fall, which is rare, you won’t benefit from it.
Variable Rate Loans
On the flipside of fixed-rate loans, there are variable-rate loans. With variable-rate loans, the interest rate can fall or rise depending on the market. There’s usually a cap on how much the rate can change over a specified period of time, and variable-rate loans usually have a much lower APR than fixed-rate loans. However, since the interest rates and monthly payments fluctuate frequently, it’s more difficult to set a budget, and you may pay a higher rate if interest rates rise.
Understanding the different types of personal loans and the pros and cons of each is key to finding the right loan for you. Once you decide which type of personal loan works for you, make sure you do your research and shop around to find the best lender.