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Types of personal loans and how they work

Different types of personal loans

Each type of personal loan has advantages and disadvantages. Your unique situation will help you decide which is best for you.

Secured Personal Loan

A secured loan – as the name suggests – secures the loan for the lender with collateral. If you default on your loan payments, the terms of a secured loan allow your lender to take possession of the collateral as payment.

Although secured personal loans require borrowers to risk an asset as collateral, this allows borrowers to access reduced interest rates. In addition, secured personal loans allow borrowers whose poor credit ratings would otherwise prevent them from taking out debt to obtain credit.

Unsecured Personal Loan

Unsecured Personal Loans are typical rather than guaranteed. Borrowers with sufficient credit (usually 600 or higher) can access unsecured personal loans. Your credit score determines how much your lender is willing to lend you. The better your credit score, the lower the interest rate you can get from your lender. However, unsecured personal loans rarely have an interest rate as low as secured loans.

Fixed rate and variable rate loans

Interest rates on personal loans come in two types: fixed and variable.

Fixed rate loans have an interest rate that never changes. The permanent rate allows borrowers to always make the same monthly payment and not worry about a floating rate increasing their payment out of the blue. However, fixed interest rates are unlikely to be as low as variable interest rates can be.

Adjustable rate loans (sometimes referred to as adjustable rate loans) offer borrowers an introductory period with an interest rate that is often lower than a fixed rate loan. After the initial period expires, the interest rate adjusts and changes based on trends in the larger credit market. Preset upper and lower limits determine how far your interest rate can go up or down.

Adjustable rate loans are great for borrowers who can pay off the loan before the introductory rate expires. However, borrowers who plan to carry the loan debt throughout the term may find a fixed-rate loan cheaper because it doesn’t come with rising interest rates.

Debt Consolidation Loan

debt consolidation Loans are a popular option for borrowers facing multiple debilitating debts. Ideally, debt consolidation loans allow you to consolidate all of your debt into one account that charges less interest than the original debt.

For example, they are often helpful with credit card debt and student loans. By making an affordable monthly payment, you can tackle your debt efficiently and avoid paying off multiple debts with high interest rates.

However, debt restructuring loans are only beneficial if they save you money. Therefore, it is recommended that you confirm with your lender what interest rate they will charge you, whether the interest rate is fixed or variable, and what your monthly payment will be. Additionally, just like most other loans, debt consolidation loans have processing fees, so taking out a loan without doing your homework could be an expensive mistake.

Richard Dement

The author Richard Dement