Personal loans are one of the most straightforward ways of accessing a cash injection when you need it most. Depending on your credit history, banks will lend you anywhere from a few hundred dollars to tens of thousands of dollars, to be paid back at a fixed interest rate over 1-5 years.
Whether you’re strapped for money in an emergency, need to make an expensive purchase or are trying to consolidate multiple loans into one manageable scheme, here are the important details to help you understand some of the types of personal loans that are available.
Secured vs unsecured loans
A common misconception is that a personal loan can either be secured or unsecured, and it’s worth making a distinction at the outset. With a secured loan, the money you’re borrowing is tied to a high-value item you own, such as your car or house. Should you fail to make repayments, your lender can take ownership of this item in order to recoup their loss. There’s interest to pay and, usually, fees but they’re likely to be lower than those for an unsecured loan.
With an unsecured loan, there’s no collateral – the loan is personal. All that happens is that you borrow money and agree to pay it back in installments over a fixed term. The higher your credit score, the more you will be able to borrow. Interest rates and fees are typically higher than with a secured loan.
Unsecured, personal loans come in many shapes and guises. Here are some of the most common types of arrangements you are likely to encounter:
Typically, if you want to take out a personal loan, you would approach a bank, building society or other financial lender and apply for what is technically a straightforward installment loan.
You will be charged interest, usually on a fixed rate basis, and there may be an arrangement fee too. All you have to do is to pay back the loan in regular monthly installments, for a period up to 3 years.
Bank overdrafts and credit cards
If you are looking to bridge a cash flow gap or need money quickly, an overdraft on your current account may be the most convenient way. Overdrafts differ greatly and it’s important to understand the bank’s overdraft terms and conditions before you use the facility.
Alternatively, you could use your credit card to pay for a high value purchase – say a piece of furniture or even a car – then pay off varying amounts every month until the debt is cleared. Be careful with credit card interest rates that can quickly add to the existing debt and make it difficult to pay it off.
Guarantor loans are another type of unsecured loan. For the most part, they work in the same way as any other unsecured loan – you borrow a fixed amount and pay it back over an agreed period. However, with this type of loan you also sign up with a friend or family member who is prepared to cover your payments if you fall behind.
The amount you can borrow tends to vary and you will still pay interest on that sum – however it might be slightly better than a loan without a guarantor as lenders perceive their risk as being much lower. Your monthly payments will be the same each month, making it easier to plan your spending.
Peer to peer borrowing
A less conventional route is peer to peer borrowing where, instead of a bank or building society, the loan is provided by individual savers that want a return on their money.
In terms of how the money is paid into your bank account and how repayments are made, a peer to peer loan is no different than a normal loan. However, you will actually owe money to several – possibly even hundreds of separate lenders that are using the platform.
The good thing about peer to peer borrowing is that you can individual borrowers can access up to $40,000. There are fewer limits if you have bad credit and you can get money quite quickly. On the other hand, the best rates will still only be available to those with good credit scores and fees may still be applied.
Rather than regular repayment installments being fixed over a period of time, a payday loan is typically repaid on the borrower’s next payday. This makes this type of credit more suitable as a short-term solution, often used as a last resort to cover a small-ish shortfall in cash flow of no more than a few hundred dollars.
Interest rates tend to be very high and can mount up quickly – triple digit APRs are not uncommon. Unless the original payday loan is paid off as agreed, there’s a real risk of getting into more debt as a consequence – it’s a risky arrangement.
Also sometimes known as home credit loans, the main characteristic of this type of credit is that its cash delivered straight to your home. The lender’s agent will visit you at home and process the loan application – usually a few hundred dollars – and make the cash funds available. He will then return on a weekly basis to collect your cash repayments until the loan is paid off in full.
Repayment periods are flexible and can be tailored to suit your financial circumstances but interest rates can be extremely high and it’s easy to get caught up in a spiral of increasing debt. Since this is a cash service, a bank account is not required, and a bad credit rating shouldn’t be a problem either.