There are so many different types of loans out there, it can be hard to know which one you should be taking out for your particular circumstances. We are going to take you through exactly what a personal loan is, when it’s a good option to take one out, the different types of personal loans and finally the advantages and disadvantages of them.
What is a Personal Loan?
As the name suggests, a personal loan is a type of loan you take out for yourself. They are fairly straightforward to process. You borrow a specific amount of money from a financial institution, and then repay this amount, including interest, over a set amount of time.
In fact, personal loans work very similarly to credit cards, but with one big difference – they tend to be much cheaper. Most people have heard of and possess a credit card for day-to-day transactions, yet would not consider a loan based on misconceptions about them only being for large amounts and for those in extensive debt. Personal loans are no different from taking out a credit card, and you may, in fact, find that you can save some money by taking one out.
Different Types of Personal Loans
There are two types of personal loans:
- Secured loan
- Unsecured loan
A secured loan works by you offering something up as security in the event that you are unable to pay your repayments. As you would expect, these loans come with a lower interest rate attached as there is less risk being taken on by the lender. They know that if you fail to meet the repayments, they are entitled to the asset you have chosen. You can offer up your house, your car, or another big-ticket item, and then this is used as security against your debt.
An unsecured loan is the opposite, where nothing is offered up as security for the debt. The interest on this type of loan is higher, as you would expect. The lender has no security that they will get the money back from you. If you do fail to make the repayments, they may choose to take you to court.
Whether you opt for a secured or unsecured loan, it is important to weigh up the interest costs of both and decide what works for your circumstances.
So, the question is, should I be taking out a personal loan?
The answer to this isn’t so black and white. Here are some advantages for you to consider.
Advantages of a Personal Loan:
- They are versatile: unlike other types of loans, such as a mortgage, a personal loan can be used for whatever you like. Whether you have unexpected medical expenses, are looking to renovate your home, or want to take off on holiday, you choose where that money goes.
- Better interest rates: as mentioned above, personal loans offer better interest rates than credit cards, making them a better option if you need a small, quick cash injection.
- You don’t need great credit: unlike many other loans that are based largely on your credit score, personal loans are possible with bad credit. You will end up paying higher rates though.
- Borrow what you need: if you have an end goal in mind (such as renovating your bathroom), then you only need to borrow the money to cover this. You set the amount and pay it back over time.
- Approved quickly: personal loans after often smaller than other types of loans on offer, and for this reason, they can be approved quite quickly. Once approved, you have access to the money within a few days.
Personal loans also come with their disadvantages, which also need to be weighed up.
Disadvantages of Personal Loans
- You are locked in: your payments are made monthly and are fixed in with a certain amount to pay off. While credit cards give you extra time to pay off the balance, if you miss a loan repayment the lender can take you to court.
- Origination fees: many personal loans come with something called an ‘origination fee’, which covers the cost of processing the loan and amounts to about 1 to 6 percent of what is being borrowed.
- Debt cycle: personal loans can also encourage a cycle of debt, as people take out loans to cover other loans and pay for things they can’t afford.
In the end, the decision of whether or not to take out a personal loan comes down to your individual circumstances. By weighing up the pros and cons you are able to work out what is best for you and what you need.
Personal loans can be extremely helpful when you need them, so make sure you look into all the pros and cons when it comes to weighing up your options.