Different types of personal loans

If you need quick money to pay for an expensive car repair, consolidate credit card debt, or cover the cost of a new furnace or hot water heater, a personal loan could be an option.

These smaller loans – usually for amounts ranging from $1,000 to $50,000 – typically come with a fixed interest rate that doesn’t change over the life of your loan. You also don’t have to provide collateral, such as a home or car, when taking out a personal loan, like you would with an auto or home equity loan.

There are several types of personal loans to meet your needs. The right one depends on how you want to use the money.

Unsecured personal loans

The most common type of personal loan is an unsecured one. An unsecured personal loan is not backed by any collateral. That differs from loans such as a mortgage, which is backed by a home, or an auto loan, backed by your car.

When you take out an unsecured personal loan, your lender can’t take your home or auto if you stop making payments. If you stop making your auto loan payments, your lender can repossess your car. And if you stop making your mortgage payments, your lender can foreclose on your home.

Unsecured personal loans pose less risk for borrowers. However, they are riskier for lenders, so they typically come with higher interest rates than mortgages or auto loans.

The amount you can borrow varies, with lenders usually offering personal loans of $1,000 to $50,000, though some might offer more. You’ll pay back what you borrow with a fixed monthly payment. Loan terms vary, but you’ll usually have 1 to 5 years to repay a personal loan.

This could be a good loan option if you have a strong credit score. If you don’t, your loan might come with an interest rate that isn’t much lower than what you’d get with a credit card.

Secured personal loans

A secured personal loan is backed by collateral. This collateral can vary, but you might pledge your car, the money in a savings account, the funds you’ve saved in a certificate of deposit, a boat, or your home.

Say you use your car as collateral. If you default on your loan payments, your lender can repossess the vehicle and take ownership of it.

Because a secured personal loan poses less risk for lenders, they usually come with lower interest rates. This could be a good choice if you are sure you will make your payments on time. Just be careful that you don’t fall behind. You don’t want to lose your collateral.

Fixed-rate personal loans

As their name suggests, fixed-rate personal loans have interest rates that never change. Your rate on your first payment will be the same as on your last. This makes it easier to budget: Your monthly payment won’t change throughout the term of your loan. On the downside, your loan’s annual percentage rate might be higher at the start of your loan’s term than if you chose a variable-rate personal loan.

Adjustable-rate personal loan

With an adjustable-rate personal loan, your interest rate can change throughout your loan term. It varies, but the rates with adjustable-rate personal loans typically rise or fall monthly, quarterly, or annually. Whether your rate rises or falls will depend on the performance of whatever economic index your loan is tied to.

The initial interest rate with an adjustable-rate personal loan is usually lower than what you’d get with a fixed-rate version, which will result in an initial monthly payment that is lower, too. But adjustable-rate loans come with more uncertainty: If your interest rate rises during an adjustment period, your monthly payment will jump, too.

These loans could be a good option for borrowers who plan on paying their loans off early, perhaps before their first adjustment periods.

How personal loans are used

Lenders offer personal loans that you can use in various ways, from paying off high-interest-rate credit card debt to building your credit score.

Here is a look at the different kinds of personal loans and what you can do with them.

Debt consolidation loans

With a debt consolidation loan, you can consolidate your credit card, medical, auto loan, and other debts into one loan. This leaves you with one monthly payment instead of several. It might also leave you with a lower interest rate, saving you money as you pay off your debt.

Say you owe $10,000 in credit card debt with interest rates varying from 24.99% to 29.99% and an auto loan with an interest rate of 7%. If you qualify for a debt consolidation loan with an interest rate of 11%, you might save money because you are no longer dealing with those high credit card interest rates.

Co-signed loans

What if your credit is too weak to qualify for a personal loan? You can search for a lender that allows co-signers.

A co-signer, usually a relative or close friend, signs your loan application. This co-signer is responsible for your personal loan payments if you fail to make them.

Lenders are more willing to approve borrowers with weak credit if they bring a co-signer. That's because even if you fail to make your payments, your co-signer can pay up, reducing the risk that your lender takes on.

It's important for friends or relatives to only co-sign a personal loan if they are sure the loan's primary borrower will make the payments on time.

Credit builder loans

With a credit builder loan, you can build credit without using a credit card. You also won’t have to worry about finding someone to co-sign a loan.

Here's how credit builder loans work: You deposit money with a bank or credit union. This becomes your loan. You then make regular payments to pay off that loan. When you finish making your payments, you receive your deposit back.

These loans are designed for rebuilding weak or limited credit. Every on-time payment you make is reported to the three national credit bureaus. These on-time payments will help your credit score rise. Once your score is high enough, you can apply for better loans and credit cards.

Terms vary, but you'll usually repay your credit builder loan over 6 to 24 months.

Home Improvement Loan

Need to make repairs or renovations to your home? You might choose a personal loan for home improvements.

These are an alternative to home equity loans or lines of credit for borrowers who worry about losing their homes. With home equity loans, your home serves as collateral. If you stop making your payments, your lender can foreclose on your residence.

This can't happen with an unsecured personal loan because these loans require no collateral. Be careful, though: Because unsecured personal loans are riskier, your lender might charge an interest rate higher than you'd get with a home equity loan or line of credit.

Types of personal loans to avoid

There are some personal loans that you should always avoid. Some lenders prey on borrowers with weak credit or those struggling to pay their bills. The loans they offer are often known as predatory loans because they come with such high interest rates and fees. Borrowers’ financial problems often increase when they take out these more expensive loans.

What personal loan types should you avoid?

• Payday loans: These unsecured loans are infamous for their sky-high interest rates and short repayment periods. Lenders typically charge high fees for these loans, which can further harm the financial health of borrowers.
• Pawn shop loans: You can get a short-term loan from a pawn shop, but this isn’t a good move. These loans also come with high interest rates and fees. You’ll also need to put up some collateral, such as a TV or jewelry you already own. If you don’t repay your loan, the pawn shop can keep the item you used as collateral.
• Wedding loans: Couples can use these personal loans to pay for their wedding costs. It’s better to save your money and pay for your wedding in cash. You might also consider reducing your wedding costs by choosing a more affordable venue or trimming your guest list. This way, you can avoid wedding loan fees and interest rates.
• Vacation loans: These are smaller personal loans that you can take out to help fund the cost of an upcoming trip. Because vacations aren’t necessities, it’s better to save money to pay for a vacation in cash instead. Paying extra fees or a potentially high interest rate to fund a vacation does not make good financial sense.

FAQs About The Different Types Of Personal Loans

Questions about personal loans? Here are some answers.

Which type of loan has the highest interest rates?

Payday loans typically come with exorbitant interest rates. The Center for Responsible Lending in 2023 said that annual interest rates range from 140% to 662% in states still allowing payday loans.

Which type of personal loan has the lowest interest rates?

You’ll qualify for lower interest rates if you apply for a secured personal loan, one that is backed by collateral. To qualify for one of these loans, you’ll need to use your home, car, boat, cash, or other items as collateral. If you stop making payments, your lender can take ownership of your collateral. That makes these loans riskier for borrowers, even with lower interest rates.

Which personal loans will affect my credit score?

All of them. When you apply for a personal loan, your lender will check your credit. This is a hard inquiry and will lower your credit score by a small amount, usually up to five points. This dip is only temporary. If you make your monthly payments on time and pay down your credit card debt, your score will recover quickly. A personal loan can also affect your credit if you make late or miss payments. These financial missteps will cause your credit score to plunge.

What fees can I expect with a personal loan?

Each lender varies, but you can expect to pay origination, late payment, and pre-payment fees when you take out a personal loan.

The bottom line

No matter which personal loan type you choose, shop around for the best interest rate and lowest fees. This step can save you hundreds of dollars.

If you’re ready to take the next step, apply for a personal loan with Rocket Loans ^SM today.