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Types of Personal Loans: Unsecured vs. Secured

tl;dr

What You Need To Know

  • The possibilities are endless with personal loans. Get the money you need for debt consolidation, home repairs, emergency expenses – and everything in between
  • Personal loans are either secured (hint: they require collateral) or unsecured
  • Your credit score and creditworthiness affects what kind of personal loan you’ll qualify for

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Who hasn’t needed a little extra cash now and again? 

If you need more money than your credit card limit offers and don’t want to dip into your savings or take money out of an investment or retirement account, a personal loan might do the trick! 

A personal loan is money you borrow from a bank, credit union or other lender and pay back over a set period of time.

The amount the lender charges you in interest will depend on the size of the loan, the length of the repayment period and your creditworthiness.

One of the key benefits of a personal loan is that you can usually get your money quickly. Often in 7 – 10 days and, sometimes, in as little as 24 hours.

Trying to decide if a personal loan is right for you? Well, knowing the difference between the available loan types – unsecured and secured personal loans – might help you make a decision. 

Unsecured Loans vs. Secured Loans

The key difference between an unsecured loan and a secured loan is collateral (that’s personal property the borrower agrees to give up if they can’t repay the loan). 

Unsecured personal loan 

A lender won’t ask a borrower to put up any collateral for an unsecured personal loan. (A student loan is a good example of an unsecured loan because the lender can’t repossess your education.)

Lenders usually charge higher interest rates for unsecured loans and tend to limit the amount of money they offer. Most lenders offer personal loans ranging from $3,000 – $50,000, with some offering loans for as much as $100,000. 

A lender will decide how much money to lend based on your creditworthiness. They’ll also use your creditworthiness to set the loan’s interest rate and other terms. Interest rates can vary, but usually range from 5% – 36%.

Their repayment terms usually range from 12 – 60 months (1 – 5 years). Longer repayment terms are available, but be careful, it can end up costing more in the long run because you’ll be paying interest over a longer period.

Your creditworthiness is usually based on several factors, including your credit score, credit history, income and debt-to-income (DTI) ratio.

Secured loans

Secured loans require collateral (think: cars and homes). Some lenders can even offer loans that use personal savings or other financial assets as collateral. 

While secured loans can be useful if you plan on buying a car or have a home you can use as collateral, most personal loans are unsecured.

What Secured and Unsecured Personal Loans Have in Common

Whether they’re secured or unsecured, most personal loans have two big things in common: They’re paid in monthly installments and they usually have fixed interest rates.

Installment loans vs. Revolving credit

With an installment loan, you make fixed, recurring monthly payments for a predetermined period of time until the loan is paid off. 

Most personal loans are installment loans. A borrower usually has 3 – 8 years to repay a loan.

This is different from the revolving credit you may have on your credit card. With revolving credit, you borrow against your credit limit and can make minimum payments each month. You decide how much you want to spend, and you pay interest on the remaining balance every month. 

A revolving credit line gives you greater flexibility, but how much you owe and the interest you pay can creep up over time.

Fixed-rate and adjustable loan rate options

Most secured and unsecured personal loans are fixed-interest loans. Which means the interest rate is set, and your payments stay the same over the life of the loan. That makes budgeting easier, and you don’t ever have to worry about your payments going up.

But, some lenders offer variable (or adjustable) rates on personal loans. You get a lower interest rate at the start of the loan, but after the introductory period, the interest rate gets “adjusted” to the rate set by the Federal Reserve. 

With interest rates currently at record lows, the interest on a variable-rate loan is more likely to go up when interest rates return to historic norms. Variable-rate loans are clutch if you can pay them off during the lower-interest introductory period because they may get expensive later on.

Common Uses for Personal Loans

Unless it’s a lender no-no, most personal loans can be used for any purpose. Lenders may promote specific-use loans, like:

  • Debt consolidation loans: You can use these loans to pay off higher-interest debt like credit card debt or consolidate multiple debts into one payment.
  • Home repair and improvement loans: These loans can help when you need to make home improvements and can’t get a home equity loan or HELOC.
  • Medical loans: These loans pay for expected medical expenses that aren’t covered by insurance.
  • Vacation or celebration loans: Some people find it helpful to take out a personal loan to cover a dream vacation or a major life celebration (like a wedding).

Personal Loans: Good Credit vs. Bad Credit

Most personal loans require a FICO® credit score somewhere in the mid-600s or higher. 

If your credit score is low, it may be harder to get approved for a personal loan. But there are options for you to get a loan or use a loan to rebuild your credit.

Unsecured personal loans with bad credit

There are unsecured personal loans designed to help borrowers with low credit scores between 300 and the low 600s. The interest rates will be high (often between 25% and 35%), but the lender reports each payment to the three major credit bureaus (Equifax®, Experian™ and TransUnion®).

Because your payments are recorded on your credit report – assuming you make them on time and in full – you can improve your payment history and build better credit.

Considering the high interest rates that come with these loans, it’s usually a good idea to look at other options that might cost you less in interest.

Secured personal loans that improve your credit

Most secured personal loans are designed for borrowers who have good credit and valuable assets, like a home, a car, a boat, an RV or other assets. 

If your credit history and your credit score don’t meet a lender’s requirement, there are secured personal loan options that let you borrow money and build your credit at the same time.

  • Credit-builder loan: The money you borrow is deposited into a bank account that is held by the lender. After each payment, money in the account is released back to you until the loan is paid back. 
  • Share-secured loan or certificate-secured loan: The loan requires borrowers to put the borrowed loan amount into a money market account or certificate of deposit (CD). 

These accounts usually require the money deposited to stay unused in exchange for a higher interest rate on the CD, so you’ll earn more in interest than you would with a credit-builder loan, but the money may not get released until the end of the loan term.

Sometimes referred to as “fresh start loans” or “starting over loans,” these loans aren’t widely advertised, so make sure and ask your lender about them if you’re interested. Payments for both of these loan types are reported to the three major credit reporting agencies (which can help you build your credit history). 

But take note: These loans only make sense if your primary goal is improving your credit score or building a credit history. The interest you earn on the money you deposit will be outweighed by the interest the lender charges you to borrow the money.

If you don’t have money to deposit, you can also secure a loan by recruiting a cosigner with better credit than you. A cosigner agrees to pay back the loan if you can’t, and that provides extra security for the lender. 

Just make sure your cosigner understands the loan’s terms and that they’re okay with them.

Which Type of Personal Loan Is Best for You?

Wondering if a personal loan is right for you? Well, if you need between $10,000 and $100,000, it may be a helpful option to get the money you need. 

Before jumping into any loan though, make sure that you understand how the loan works, how much your monthly payment will be and how long it will take you to pay off the loan.

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In Case You Missed It

Take-aways

  1. While the interest on most personal loans is fixed, some lenders do offer variable or adjustable-rate loans
  2. Some secured personal loans let you build your credit score by allowing you to borrow against money you deposit in a savings, money market account or certificate of deposit
  3. There are personal loans available if you have bad credit, but the loans usually come with higher-than-average interest rates

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