What is a personal loan?
A personal loan – sometimes called an unsecured loan – is a loan that is not secured by collateral. A collateralized loan is secured by property that can be repossessed if the loan is not paid, such as a car or home loan. Personal loans have set terms and fixed amounts, meaning you can’t borrow more as you pay down the loan. The borrower makes monthly payments until the loan is paid in full, and then the loan is closed.
Benefits of a personal loan
A personal loan is helpful when you have an unexpected expense that you cannot afford. The interest rate for a personal loan is usually lower than that of a credit card, so you pay less in interest. Excessive credit card debt can also hurt your credit standing. Using a personal loan can help prevent negative impacts on a credit report while also building payment history.
What is the downside?
While a personal loan generally has a lower interest rate than a credit card, it usually has a higher monthly payment. When thinking about a personal loan, consider how the payment will fit with your budget. Additionally, personal loans have higher interest rates than collateralized loans. So if you own a car, you may want to look into using it as collateral before opening a personal loan to save money. Although you can build payment history with a personal loan – a key factor in building a good credit score – the loan is removed from your credit report a few years after it is paid. If your main goal is to build credit history, a credit card may be a better option because it establishes a longer payment history.
Do your research
Before making any loan decisions, always weigh the pros and cons. Make sure the monthly payment will fit into your budget and the loan will meet your financial needs. Also, talk to your financial institution about personal loan options. There may be multiple types with different features and interest rates. Making financial decisions can be overwhelming, but doing your research will help you feel more prepared and confident about your choices.