Nearly everyone faces an unexpected financial circumstance in life that requires more cash than is currently available in a checking or savings account. Borrowing with the help of a credit card is an option for some, but others may prefer the predictability of a personal loan instead.
Many banks, credit unions, and now, online lenders offer a variety of personal loans in terms of interest rates, repayment terms, and amounts available. Regardless of the lender, though, personal loans are an attractive option for borrowers because they provide a lump sum of funding in as little as a few days and extend repayment out for several months up to several years. As a long-term financing strategy, personal loans also provide a lower interest rate than some comparable borrowing options, and those interest rates are typically fixed for the duration of the loan.
In the world of personal loans, there are two main categories: secured and unsecured. Both have advantages and drawbacks that are important to understand before selecting one over the other.
Breaking down Unsecured Personal Loans
Personal loans that are offered on an unsecured basis are the most common loans made available to borrowers through traditional financial institutions and online lenders. With an unsecured personal loan, the lender determines your eligibility for the loan based on your credit history and score, as well as your ability to repay the loan given your income and other debt obligations. There is no collateral required, like a car title or another asset, and so, a strong history of financial responsibility is necessary to qualify.
Unsecured personal loans typically carry a fixed interest rate and a fixed monthly payment for a set term. Interest rates applied to unsecured personal loans vary depending on the lender you choose and your credit history, with the average rate coming in around 9%. Because of the predictable nature of an unsecured personal loan, they can be a great option for financing major purchases or unexpected expenses.
The Difference in Secured Personal Loans
Secured personal loans offer the same set repayment terms and interest rates as an unsecured personal loan, but one clear difference separates the two. Secured personal loans are backed by an asset, such as a savings or checking account, and the total amount of the loan offered is only as much as the value of the pledged account. If a loan is unpaid, the lender has the right to capture any losses by taking from the collateral account used to back the secured loan.
Because the risk of financial loss due to default is lower with secured personal loans, this financing option typically comes with a far lower interest rate than an unsecured personal loan. Secured personal loans don’t require a high credit score or history, making them a strong option for individuals who are trying to rebuild their financial reputation.
While personal loans, both secured and unsecured, offer a method to finance a large expense over an extended period of time, there are a few caveats. First, over and under borrowing are real concerns with personal loans since there is no flexibility with lump sum financing. You have to know how much you need to borrow up front, and you run the risk of borrowing too much or too little if you haven’t thought that through fully. Additionally, some personal loans come with funding fees that eat away at the total amount you receive or add to the financed amount. You may also face pre-payment penalties with a personal loan, which means if you pay off your balance sooner than the maturity date, your lender may tack on an additional charge that increases the total cost of the loan. Finally, personal loan interest rates vary widely from lender to lender, so it is necessary to shop around to ensure you secure the best terms.
Both unsecured and secured personal loans can be a smart method to stretch out repayment for a major purchase or expense, but take the time to understand your options before signing on the dotted line.
About the Author: This article was written by financial expert Rebecca Kennedy on behalf of TheNetLender – a reliable and responsible car title loans company.