What is a personal loan?
If you want to buy a new car, you get an auto loan. If you're ready to become a homeowner, a mortgage can help you finance the purchase. The reason for taking out a personal loan, on the other hand, is just that: personal.
Personal loans can be used to finance a variety of expenses, such as home renovations and maintenance, continuing education classes and online courses, and personal expenses during a financial emergency. You can also use a personal loan to consolidate high-interest debt - such as credit card debt - at a lower interest rate so you can save money and pay it off faster.
How do personal loans work?
Personal loans can be either "secured" or "unsecured." A secured loan requires you to put up collateral in order to back the loan, such as a vehicle or home. In the case you aren't able to pay back the loan, the lender will seize this collateral as payment. Although "securing" a loan this way can make it easier to qualify, it's also riskier for you if you're unable to make payments.
Many personal loans, however, are unsecured. That means you're granted a loan based on creditworthiness alone. It can be more difficult to qualify for an unsecured loan if your credit isn't in great shape, but it's also the much safer option.
Additionally, personal loans come with either fixed or variable interest rates. The best loans will offer a fixed rate, which means the rate never changes and your monthly payments will always be the same amount. Variable interest rates, on the other hand, are tied to the market and can fluctuate. Often, the introductory rate will be quite low, but there's the potential for that rate to increase in the future.
Personal loan interest rates are determined by the individual lender. In most cases, though, your rate will depend on your credit history and score. The better your credit, the lower the rate. When taking out a personal loan, it's important to get the lowest interest rate possible so you spend less over time.
Once you're granted a personal loan, you’ll receive the funds in one lump sum. Then you will pay back the loan in monthly installments until the entire balance is repaid. How long you have to pay back the loan will depend on the specific terms of your loan.
Are there any downsides to personal loans?
As mentioned above, a personal loan can be tricky if you have to secure it with a personal asset or have to pay a variable interest rate. It's always a good idea to shop around for an unsecured personal loan that comes with a low, fixed rate.
However, at the end of the day, any personal loan is still debt that you are responsible for paying back. If you don't make all your payments on time and in full, there will be pretty serious consequences to your finances. It's rarely a good idea to take on personal debt unless totally necessary, especially if you already have other types of debt such as student loans or credit cards. So if you're looking for ways to pay for a big wedding or long vacation, relying on a personal loan might not be the best idea.
Should you take out a personal loan?
Of course, sometimes borrowing money is unavoidable. Personal loans tend to come with lower interest rates than credit cards and other expensive borrowing tools. So if you’re in a position that requires you to borrow money, a personal loan can help keep interest costs down and allow you to get out of debt faster.
Personal loans can also be helpful tools if you're already in debt. For instance, you can use a personal loan to consolidate existing credit card debt. By combining your credit card balances into one loan with a much lower interest rate, you can get that debt under control and quickly pay it off.
No matter what, weigh your options carefully before taking on a personal loan and remember that like any other loan, you need to pay it back on time. Missing payments or defaulting on your loan could land you in a worse situation than before and hurt your credit for a long time.
If you are ready to apply for a personal loan, you can compare our recommended online lenders above. Be sure to check out more than one option, since your eligibility and interest rate can vary depending on the lender.