Types of Personal Loans: How to Choose the Right One for Your Needs

What Is a Personal Loan?

A personal loan is a type of installment loan that you can use for almost any legal purpose. Unlike a student loan or a car loan, there are usually no restrictions on how you spend the money. Whether you need to cover an emergency expense, consolidate debt, or finance a wedding, a personal loan gives you a lump sum that you repay in fixed monthly payments over a set term.

Personal loans are typically unsecured, meaning they don’t require collateral like your home or car. However, some personal loans are secured, and those may come with different interest rates and terms. Because personal loans are general-purpose, they offer flexibility that is not available with more specialized loan products.

• Can be used for any legal purpose, including medical bills, home improvements, travel, or debt consolidation.
• Usually repaid in fixed installments over a term of two to seven years.
• May be secured (backed by collateral) or unsecured (no collateral).

Sources: OneMain Financial, Experian

Types of Personal Loans

There are several ways to categorize personal loans, but the most common distinction is between secured and unsecured loans.

Secured personal loans are backed by an asset, such as a savings account, car, or home. Because the lender has collateral, these loans often come with lower interest rates. However, if you fail to repay, you risk losing the asset.

Unsecured personal loans are more common and don’t require collateral. Lenders rely on your creditworthiness to decide the rate and terms. These loans may have higher interest rates than secured ones because the lender takes on more risk.

Another key distinction is between fixed-rate and variable-rate personal loans. A fixed-rate loan keeps the same interest rate for the entire term, so your monthly payment stays predictable. Variable-rate loans, which often come in the form of a personal line of credit, may start with a lower rate but can rise or fall with market conditions, which means your payments could change.

• Secured personal loans: backed by collateral, often lower rates.
• Unsecured personal loans: no collateral, rates based on credit.
• Fixed-rate loans: consistent payments throughout the loan term.
• Variable-rate loans: payments can fluctuate with the market.

Sources: OneMain Financial, Experian, First Alliance Credit Union

Comparison of Personal Loan Types

When choosing a personal loan, it helps to compare the main types side by side. The table below summarizes the key features of secured, unsecured, fixed-rate, and variable-rate personal loans.

Sources: OneMain Financial, Experian, First Alliance Credit Union

Personal Loan Uses

Because personal loans are flexible, you can use them for almost any major purchase or expense. Common reasons people take out personal loans include:

• Debt consolidation: paying off high-interest credit card balances with a lower-rate loan.
• Emergency expenses: covering unexpected medical bills or urgent home repairs.
• Major purchases: financing a wedding, vacation, or large appliance.
• Home improvements: renovating your home without using a home equity line of credit.
• Relocation costs: covering moving expenses or transitional living costs.

Sources: OneMain Financial, Experian

Factors Affecting Personal Loan Rates

Several factors influence the interest rate you’ll be offered on a personal loan. Your credit score is one of the biggest factors. Lenders use it to gauge your likelihood of repaying the loan, and a higher score often leads to a lower rate.

The loan term also matters. Shorter terms generally carry lower interest rates because the lender’s money is at risk for less time. The size of the loan can also play a role, as can the lender’s specific underwriting criteria. Additionally, whether the loan is secured or unsecured affects the rate, as secured loans present less risk to the lender.

It’s important to note that the Annual Percentage Rate (APR) is the most complete way to compare loan costs. APR includes the interest rate plus any fees, such as origination fees, giving you a truer picture of the total cost.

• Credit score: higher scores typically get lower rates.
• Loan term: shorter terms often have lower rates.
• Loan amount: larger amounts may come with different rates.
• Secured vs. unsecured: secured loans may have lower rates.
• APR vs. interest rate: APR includes fees, so use it to compare offers.

Sources: First Alliance Credit Union, Debt.com

How to Choose a Personal Loan

Choosing the right personal loan requires you to think about your financial situation and what you need from a loan. Start by considering how much you need to borrow and what you can afford to pay each month. This will help you narrow down the loan term and type.

Next, check your credit score and see what rates you qualify for. If your credit is strong, you may qualify for a lower-rate unsecured fixed-rate loan. If you don’t qualify for the best rates or you want to lower your payment, a secured loan might be an option—but you need to be comfortable with the risk of putting up collateral.

Always compare offers from multiple lenders, looking at the APR, monthly payment, fees, and total cost. Use the APR as your main comparison tool because it includes fees. And remember to read the fine print for any origination fees, prepayment penalties, or other charges.

• Determine how much you need and how much you can repay.
• Check your credit score to know what rates to expect.
• Compare APR, monthly payment, fees, and loan terms from several lenders.
• Consider whether you are willing to use collateral to get a lower rate.
• Read the loan agreement carefully before signing.

Sources: FasterCapital, Debt.com

Risks and Pitfalls to Avoid

Personal loans can be a helpful financial tool, but they also come with risks. One of the biggest risks is taking on more debt than you can handle. Because personal loans are unsecured and have fixed payments, they can strain your budget if you lose your income or have unexpected expenses.

Watch out for fees. Many lenders charge origination fees, late fees, and other costs that can add to your loan balance. The APR will tell you the total annual cost, so comparing APRs helps you avoid overpaying.

Another pitfall is using a personal loan to consolidate debt without addressing the spending habits that created the debt in the first place. If you use a loan to pay off credit cards but then run up the cards again, you’ll end up with more debt than before.

Finally, be cautious with secured loans. While they may offer lower rates, you risk losing your collateral if you default. Always make sure you can comfortably make the payments before borrowing.

• Avoid borrowing more than you can afford to repay.
• Compare APRs to account for fees.
• Don’t use debt consolidation as a way to overspend again.
• Understand the consequences of secured loans and the risk to your assets.

Sources: Broadview Federal Credit Union, OneMain Financial, Debt.com

Decision-Criteria Matrix

To help you make a decision, here are the key criteria to evaluate when comparing personal loan offers. Keep these in mind as you review lender options.

Sources: FasterCapital, Debt.com