Last Updated: April 12, 2023
Personal loans can help you with all sorts of sticky situations like unexpected vet bills, medical bills or any other significant expense. If you require some extra money, consider taking out a personal loan.
A personal loan is one of the simplest ways to borrow money, as it's usually pretty straightforward and enables you to lend a large sum quickly. In this article, you'll learn about personal loans, the different types, the pros and cons of personal loans, and much more.
What is a Personal Loan?
Before we dive into the pros and cons of personal loans, it's a good idea to know what a personal loan is.
The general idea of a personal loan is to borrow money from a lender and receive this lump sum in your account within a few days of applying. Your loan agreement will specify the amount and payback period.
Once you've received the loan, you repay the amount plus a fixed interest rate for the agreed period. You usually must make a fixed monthly payment until you clear the balance.
There are multiple types of personal loans, each with its purpose and requirements.
In the following section, we'll explore them all.
The Different Types of Personal Loans
There isn't a one size fits all approach to personal loans. You should be aware of different types of personal loans; some are more accessible than others, and some depend solely on your credit history.
The different types of personal loans:
- Unsecured loans: require the lender to know your credit history, and you'll get an unsecured loan based solely on your credit score. So, there's no need for any collateral or someone to vouch for you.
- Secured loans: a secured personal loan requires collateral. The most common secured loan is the homeowner loan, which allows you to borrow money whilst using your house as collateral.
- Debt consolidation loans: if you've got multiple debts, you can take out a debt consolidation loan to pay them off, so you only have to repay one loan. Reducing your monthly payments and eliminating high-interest debt is the goal.
- Co-signed loans: when you sign up for one of these personal loans, you'll need a co-signer who will be obligated to take over payments if you miss any.
- Joint loans: a joint personal loan can also be applied to cover overdrafts, similar to a co-signed loan. This loan can include more than one co-signer. However, all parties signing up for the loan must ensure repayment.
- Fixed-rate loans: you'll often find a fixed-rate loan as a mortgage. The idea is that the interest rate doesn't change throughout the loan. So, the interest rate you initially agreed to will be the same.
- Variable-rate loans: this is the opposite of a fixed-rate loan. Interest rates can vary during the loan period depending on any market changes.
- Buy now, pay later loans: this personal loan is ideal for short-term financing, allowing consumers to purchase and pay for them over time.
- Payday loans: a personal loan that is for a short period but usually comes with higher interest rates than other types of personal loans. The idea is to get a loan the same amount as your salary, and then you’ll pay it all back when you can.
Now that you know all about the different types of personal loans, we have some helpful tips for you to consider before filling out any loan applications.
Tips for Taking Out a Personal Loan
Whether you want to take out an unsecured or secured loan, you should ensure your loan meets your criteria and financial needs.
Consider the following factors when looking for the best deal:
- Credit score: Lenders determine the borrowing amount by looking at your credit score and utilisation.
- Repayment period: making on-time payments is essential for staying on top of your loan. It would be best to ensure your loan term is short to avoid long-term debt.
- Loan amount: consider how much money you'd like to borrow; deciding on an exact amount will help you compare rates, and sticking to a budget will help you stay within your credit utilisation limit. Most lenders and banks will have a personal loan calculator to help you.
- Reasons for loan: loans are serious commitments that should be taken seriously, so planning what you will do with the loan will help you save money as you may not need to borrow as much.
- Compare loans: look at multiple personal loans and compare them until you find the right one for you.
- Consolidate debt: if you want to eliminate an outstanding balance on your credit card and other forms of debt, use a personal loan for consolidating debt. Lift the debt burden by choosing a loan with a lower APR than your current debt.
- Monthly payment: if you want to know what to pay monthly, pick a personal loan with a fixed interest rate. You'll have set monthly payments to know exactly how much to pay each month without worrying about variable interest rates.
- Consider alternatives to personal loans: you'll read more about this later, but you may find that there are better choices than a personal loan for your financial situation.
Like any borrowing agreement, there are many pros and cons. In the following two sections, you'll discover all the pros and cons of personal loans.
The Pros and Cons of Personal Loans
Like any financial agreement that could affect your credit report, there are benefits and drawbacks to taking out a personal loan.
We’ve researched them all for you, so you don’t have to.
Pros of Taking Out a Personal Loan:
Personal loans typically are the easiest to apply for as the process is quite simple, but there are many other benefits to taking out a personal loan. There are more pros to taking out a personal loan than cons.
Let's dive in and explore them all:
✔️ Build credit: taking out a personal loan and making monthly payments on time can help create a more favourable payment history.
✔️ Debt consolidation: If credit card debt is piling up with high interest, you can consolidate debt onto one loan. You may find a personal loan with lower interest rates than your credit cards, so you'll pay less interest in the long run.
✔️ Pay for purchases over time: a personal loan gives you some breathing room. So, if any unexpected payments come your way, a personal loan can help you spread the cost over a set period.
✔️ Competitive interest rates: annual percentage rates (APR) for personal loans are relatively low; the average interest rate ranges from 3% to 36%. The average APR for a £10,000 loan in June 2022 was 4.11%.
✔️ Flexible borrowing limits: depending on your credit utilisation and if you've got good credit, personal loans allow you to borrow up to as little as £1,000 and a maximum lump sum of £250,000.
✔️ Fast access to money: a personal loan, more specifically, an unsecured personal loan, is one of the quickest ways to borrow money. Depending on the personal loan lender, you can have the loan amount in your bank account in up to five days.
✔️ Helping hand: Knowing you've co-signed with someone you trust may provide comfort if you seek secured loans. Having someone help you with finances or being there to back you up can make you feel better about taking out a loan.
Cons of Taking Out a Personal Loan
The more you know about loans before filling out the application, the more prepared you’ll be. Personal loans have an array of pros, but you must know what cons they also have.
Let's dive in and explore them all:
❌️ High-interest rates: if you take out a personal loan with variable interest rates, you may pay interest of up to 36% APR. Each month you find yourself paying different interest rates. Alternative financing, like home equity loans, may have lower interest rates.
❌️ Credit damage: if you don't keep up with your loan monthly payments, you risk damaging your credit score.
❌️ Repayment penalties: origination fees may incur on top of the borrowed money. Be aware of additional penalties and costs if you're late with payments. If you can't make on-time payments for personal loans that require collateral, you risk losing your home and other valuable assets.
❌️ Borrowing limits: if you’ve got a poor credit report, you may be unable to borrow the entire amount you require for a major expense.
Now that we've covered the pros and cons of personal loans, you may consider other options for a personal loan. To help you with this process, we've devised a list of alternatives to personal loans that you may find more useful.
Alternatives to Personal Loans
If a personal loan doesn't feel like the right option, don't worry.
You're not entirely doomed. Personal loans are only suitable for some; there are many reasons for this incompatibility, from low credit scores to simply wanting to play it safe and avoiding the risk of losing collateral.
Other options that may help you:
- Home equity loans: you can borrow against the equity in your homes. Essentially, you'll use your house as collateral. The value of your home determines a home equity loan amount.
- Credit card: a great way to create a positive credit report, and depending on the type of credit card, you can use it to make a significant purchase or consolidate debt.
- A personal line of credit: a flexible line of credit from a financial institution similar to a credit card. You can repeatedly borrow until you reach your borrowing limits.
- Peer-to-peer loans: a great option if you've got fair or poor credit, as money borrowed from a peer-to-peer platform usually comes with lower interest rates than you'd have from a personal loan lender.
- Auto loans: if you're looking for a car loan, you can find lenders who provide this service specifically to help you purchase your next car.
- Salary advance: if you don't want to affect your credit score, consider contacting your employer and asking for a salary advance to help you in your hour of need.
Final Thoughts on Personal Loans
Whether you're looking for unsecured personal loans or secured ones, it's good to know that most are accessible. If you've insufficient funds and need a helping hand, personal loan funds can help you out of a tight squeeze.
You should be good to go if you make regular monthly payments and keep your credit card balances from overflowing!
Need help determining where to start comparing personal loans? Try CompareBanks; we help you find and compare thousands of financial products and services with the help of independent reviews and guides.
- Best Secured Loans For Bad Credit (2023)