A personal loan is a loan underwritten by your creditworthiness and repaid in fixed installments.
In a typical secured loan — like a mortgage or auto loan — the lender can repossess the item in question if you fall behind on payments.
Unsecured loans — personal loans — work a little differently. You may take one out to fund a wedding or vacation, a home improvement project or a catastrophic expense. Because there’s nothing for the lender to repossess, you’ll pay more in interest, plus any other loan fees your lender may attach.
These types of loans are called several different names:
- Personal loans.
- Unsecured personal loans.
- Installment loans.
- Signature loans.
- Debt-consolidation loans.
All these types of loans share similar traits:
Your credit scores and history determine your interest rates. Lenders look at your credit history and ability to repay the loan based on your income and debt levels. Rates start in the low single digits for those with excellent credit scores and are typically capped at a 36% annual percentage rate, which is the maximum rate that lawmakers and experts consider affordable for borrowers.
You don’t have to offer any collateral. This is the “unsecured” part of unsecured personal loans. If you fail to make payments, a lender can report that to the credit bureaus (hurting your credit scores), send the debt to collections and sue you for payment. But it does not have a legal right to seize your property. There are secured personal loans, backed by the title to your car or perhaps an investment account, that give the lender the right to seize that property if you default.
You typically can’t be forced to spend the money on a particular purpose. Generally you have complete control over how the money is spent, and since the rate depends on your credit, most lenders offer the same rate no matter how you intend to use the proceeds. There are rare exceptions: Some lenders may charge a higher rate if the stated purpose of a loan is considered riskier, such as debt consolidation rather than, say, a vacation.
Personal loans are reflected on your credit report. You should expect regular, on-time payments to be reported to at least one of the three major credit reporting agencies, and the same for late payments or defaults.
Personal loans are calculated into your credit score. An installment loan in good standing is a positive in calculating your credit score. Credit score algorithms consider both installment debt, such as personal loans, and revolving debt, such as credit cards. If you handle both types of debt responsibly — i.e., make timely payments and don’t approach your credit limit — your score can improve.
What about no-credit-check installment loans?
A no-credit-check loan, sometimes called a payday installment loan, offers nearly instant cash. Like other personal loans, it is repaid in fixed installments with a loan term ranging from a few months to years.
But these lenders don’t check your credit scores or your ability to repay the loan. All you typically need is a bank account and no bankruptcies to qualify for a loan. But there’s a catch — because of the risk involved in extending credit without a credit check, you will pay interest rates of 100%, 200% or more, which could drown you in debt over time.
Most lenders will send your debt to collections if you don’t pay, which could show up on your credit report and affect your credit score.
Is there such a thing as a secured personal loan?
Yes. Some lenders will lend money to borrowers who pledge a car they already own or a savings account. The collateral may help a borrower with poor credit qualify for a loan, get a better rate or get a bigger loan.
Other types of personal loans
Other common types of lending may be known as personal loans but actually aren’t.
A payday loan or a cash advance loan is also a type of unsecured loan, but it is typically repaid in a lump sum on a borrower’s payday, rather than in installments. Amounts tend to be a few hundred dollars or less. Payday lenders don’t check your credit or report on-time payments to credit bureaus. If you don’t repay the loan, it could be sold to a collections agency that reports the delinquency to the credit bureaus. These are short-term loans; most borrowers wind up taking out additional loans when they can’t repay the first. That means interest charges mount quickly, and loans with APRs of 1,000% or more are not uncommon.
A line of credit is a personal loan approved ahead of time but drawn when you need it, in the amount you decide, up to your limit. That makes it revolving credit, similar to a credit card, rather than a true personal loan. Banks and credit unions extend personal lines of credit to customers with good credit histories. A secured line of credit is a similar arrangement with a house or securities as collateral, with a lower interest rate in return.
A credit card cash advance is a loan drawn against your credit card limit. The payments aren’t fixed, like a personal loan. Interest rates on credit card cash advances tend to be significantly higher than those for purchases, and typically there is a fee of 2% to 5% of the amount borrowed.
A pawnshop loan is a secured personal loan. You borrow against an asset such as jewelry or electronics and leave it as security with the pawnshop. If you don’t repay the loan, the shop can sell the property. Rates are very high — not unlike payday loans — but you do not risk a lawsuit or damage to credit if you don’t repay the loan. You just lose your property.