Discover the different types of personal loans

Some loans are made for one type of purchase, like mortgages and car loans. Personal loans are a much more flexible option. You could use one to consolidate credit card debt, cover an unexpected emergency, make home improvements, or pay for almost any other expense you have.

A personal loan is money you borrow as a lump sum and pay back in regular monthly installments over a set term. Personal loans can be either secured or unsecured, with either a fixed rate or a variable rate.

Here’s how these different types of personal loans work.

Secured vs. unsecured personal loans

Secured loans

Secured loans are backed by collateral—that means you pledge something of value as a guarantee that you’ll repay the debt. Usually, the collateral is the thing you borrowed for—a car is the collateral for a car loan, and a home is the collateral for a mortgage.

But you can find secured personal loans, too. Some lenders offer secured personal loans if you have something of value to pledge, such as:

• A savings account or certificate of deposit (CD)

• A vehicle you own

• Life insurance policy with cash value

• Valuable jewelry or artwork

• Investments, like stocks or bonds

• Anything of value that the lender is willing to accept

The way it works is that the lender puts a lien on the asset you're pledging as collateral. A lien is a legal claim to that asset. The lien gives the lien-holder (the lender) the right to take the asset, or the money in the account, to cover what you owe if you default on the debt. If the collateral doesn’t fully cover what you owe, you still owe the difference. Liens are removed when the debt is paid off.

The idea of a lien might sound unappealing, since the lender could seize your property if you default. However, that could be what makes it work in your favor. Collateral lowers the risk of financial loss for the lender. Pledging collateral could help you qualify for a loan or get a lower rate than you would on an unsecured loan.

Your credit, income, and debts still matter when applying for a secured loan.

Unsecured loans

Unsecured loans aren’t backed by collateral. Approval depends entirely on your creditworthiness, your income, and how much other debt you have. Most personal loans are unsecured.

The interest rates can be higher compared to secured loans, to account for the extra risk of not having collateral. Here’s another way to look at the additional risk: If you default on an unsecured personal loan, the lender can’t automatically seize any assets, because the loan doesn’t have collateral.

That doesn't mean unsecured loans are entirely without risk. Missed payments can still hurt your credit, and defaulting on your loan could lead to collection efforts, including a potential debt lawsuit.

Fixed-rate vs. variable-rate personal loans

Fixed-rate personal loans

The interest rate on a loan can either be fixed or variable. Most personal loans have fixed interest rates.

A fixed-rate personal loan has an interest rate that's set for the life of the loan. The rate will never change, so your monthly payment won't either.

A stable, consistent payment can help you budget for the future. The downside is that if rates fall after you get your loan, your rate will stay the same. You may be able to refinance, depending on how much rates drop.

Variable-rate personal loans

A variable-rate loan has an interest rate that can change while you're paying off the loan. Variable-rate personal loans are uncommon, although some banks and credit unions offer them.

Variable interest rates are typically tied to a benchmark, usually the prime rate, plus a margin set by the lender. The prime rate normally moves when the Federal Reserve raises or lowers interest rates. When the benchmark rises, the rate on your variable-rate loan usually rises. When the benchmark falls, your loan’s rate could also fall.

Loans with variable interest rates often start with lower rates than comparable fixed-rate loans. The tradeoff is that if interest rates rise, variable-rate loans become more expensive. The rate and the monthly payment could increase, which is a risk you don’t have if you get a fixed-rate loan.

Personal loan repayment terms

The loan agreement tells you how long you have to repay the loan. Lenders call this length the loan term or the loan repayment period.

One nice feature of personal loans is that you can often pick the repayment term that fits your budget. The longer the loan term, the lower the monthly payment will be. Potentially good for your budget, but you'll pay more interest over time.

A shorter loan term increases the required monthly payment but brings down your total interest charges. Personal loans with shorter terms often come with lower interest rates, as well.

Personal loan repayment terms usually range from two to seven years, although some lenders offer longer or shorter terms. To pick a term, start with the monthly payment that fits your budget and your target payoff date. Let those two goals guide the length you choose.

Debt consolidation loans

A debt consolidation loan is a personal loan to pay off other debt. Most debt consolidation loans are unsecured and have a fixed interest rate.

After you’re approved for a debt consolidation loan and receive the money, you can use it to pay off your other debts. Some lenders are also willing to pay off your other creditors directly, using your loan funds. Direct payoff can be helpful because it ensures that your debts get paid and that the loan money doesn’t sit around in your checking account. In addition, some lenders may offer a discount on your interest rate if you opt for a direct payoff.

Debt consolidation could relieve financial stress in a few ways:

• Since you pay off multiple debts with a debt consolidation loan, you end up with fewer monthly payments to manage.

• The debt consolidation loan may have a lower interest rate than the debts you want to pay off.

• Using a personal loan to pay credit card debt could also provide a structured debt payoff timeline. Credit card debt is open-ended with no fixed end date. With a personal loan, you know the term and the end date upfront.

If you pay off credit cards with a debt consolidation loan, be careful not to run up balances on your cards again. Otherwise, you could end up with even more debt than before.

Payday loans

Payday loans are small personal loans, generally for $500 or less, usually with the balance due within two to four weeks. The way it usually works is you provide your bank details and give permission for the lender to take the money out of your account on your next payday.

Due to the short repayment period, most borrowers have a hard time paying payday loans back by the due date and have to renew the loan multiple times. You could end up paying far more in fees than the amount you borrowed.

Payday loans may seem affordable, but the cost is extremely high compared to the loan amount. A typical two-week payday loan may carry a fee of $15 for every $100 you borrow, which equates to an APR (annual percentage rate) of nearly 400%.

You’re almost always better off avoiding payday loans because of their high fees and short repayment terms. Credit cards and personal loans are usually much more affordable. Payday alternative loans (PALs) are another option, available at some federal credit unions if you’ve been a member for at least one month. PALs can have an APR of up to 28% and application fees of up to $20.

Uses for different types of personal loans

You'll find many reasons to apply for a personal loan. Most personal loans can be used for just about anything. They’re generally best for short- or mid-term expenses, such as an emergency or a large purchase you want to pay for over time. A long-term purchase, such as a home, isn't an option for a personal loan, though a car may be.

Here are some of the many different uses for personal loans:

• Credit card debt

• Medical expenses

• Dental work

• Car purchase or repairs

• Funeral costs

• Home appliance repair or purchase

• Home improvements

• Vet bills

• Moving expenses

• Emergency expenses

• Temporary financial hardships

How to choose the right personal loan

The right personal loan matches your goal, your budget, and the amount you need. Here's what to weigh before you apply:

• Loan type: Choose a fixed-rate installment loan for predictable payments. Consider a secured option if you have an asset to pledge and are comfortable putting it on the line to potentially secure a lower rate.

• Loan amount: Borrow only what your goal costs, so you don't pay interest on money you won't use. If a loan has an origination fee, many lenders deduct this fee directly from the loan amount. You may need to borrow a little extra to account for the cost of the fee.

• Repayment timeline: Pick a term with a monthly payment your budget can handle and a payoff date you're comfortable with.

• Fees and rate structure: Review the APR, which includes interest and fees, and whether the rate is fixed or variable, so you know what to expect.

Achieve Personal Loans could be a good place to start. You can prequalify to check estimated rates and terms with a soft inquiry, which doesn’t affect your credit score. Final terms depend on full underwriting and may differ from the estimate. Find out if you're eligible today.