With credit card interest rates soaring as high as 30%, people continue to look for alternatives to credit cards, such as personal loans. Personal loan interest rates are often lower than credit card interest rates. The actual rate on the personal loan will be largely dependent on your income, your credit score, and your payment history. The higher your credit score and income, the lower your interest rate will be.
Some personal loans will come with a variable interest rate that change periodically while many others will have a fixed interest rate. Interest rates can also vary by bank and state, thus it is important that you do as much research as possible to find the best rate for your personal loan. This means the interest rate is locked and doesn’t change for the term of the loan.
The interest rate on your personal loan also depends on whether you take out a secured loan or an unsecured loan. The interest rate on unsecured loans is higher than the interest rate on secured loans.
Secured Loans Interest Rates
A secured loan is guaranteed by an asset. In order to borrow money, the borrower needs to first pledge an asset as collateral. The lender can take possession of this asset if you default and cannot pay off your loan. For example, when you take out a mortgage loan for a house, the asset that you pledge is the house itself. When you default, the bank has the right to take away your house. Using an asset as collateral ensures the lender that the borrower intends to repay the loan. This makes secured loans good risks for lenders, and thus they are able to offer lower interest rates.
Unsecured Loans Interest Rates
Unsecured loans are not backed by an asset. Since no property is used to guarantee this type of loan, it is a greater risk for the lender. Because of the greater risk, the lender charges higher interest rates.
Even though the interest rates on unsecured loans are higher than those of secured loans, unsecured loan interest rates are still usually lower than credit card rates, especially if you have a good credit score. If a secured loan is not an option for you because you do not want to risk pledging an asset, then you might want to consider looking into an unsecured personal loan.
A personal loan can either be secured or unsecured. A secured loan is backed by a type of asset that is used as collateral in case you default. In the event that you cannot pay off your loan, the lender can take the asset. For example, a mortgage is a secured loan backed by real estate. Other items such as stocks, bonds, or personal property can be used to secure a loan as well. Having this collateral reassures the lender that you have the intent to pay back your debt.
Examples of Secured Loans:
- Home Equity Line of Credit
- Auto Loan
Unsecured personal loans, also known as “signature loans,” don’t require borrowers to use any asset as collateral. Rather, the institution will loan you money with just your signature. This means that if you default and are unable to make payments for the loan, the lender can’t automatically take your house or car as payment for the loan. However, the bank can still take legal action against you for their payment, such as filing a lawsuit. The higher risk for lenders is the main reason why unsecured personal loans are difficult to get.
Examples of Unsecured Loans:
- Credit Cards
- Personal Lines of Credit
- Student Loans
Secured loans usually offer lower interest rates, higher borrowing limits, and longer repayment terms than unsecured loans. It is also important to remember that if you are unable to repay a secured loan, the lender has the right to the collateral you pledged and may sell off that asset in order to pay off your debt.
As with any loan, it helps to shop around rather taking a loan from the first lender who offers you one. Before you apply for any personal loan, make sure:
- the personal loan interest rate is reasonable. If you can get a better interest rate on a personal loan than a credit card, it might make sense to take out a personal loan.
- you fully understand what you are doing and are informed. Make sure there are no hidden costs.
- that this solution of getting a personal loan will be of a real long-term benefit to you and not just a short-term fix.
Many people encounter emergency situations where unexpected expenses occur and they need additional cash. One way to borrow this cash is through an unsecured loan. Unsecured loans do not require the borrower to pledge an asset, such as their home or car, as collateral. Thus, if you default on an unsecured personal loan, the lender can’t automatically take a piece of your property as payment for the loan.
Examples of Unsecured Loans:
Advantages of Unsecured Loans
One advantage of unsecured loans is that you will not risk losing any of your assets if you are unable to pay back the loan. This type of loan is especially appealing to people who have limited assets. For example, these might be a good option for those who do not have enough equity in their homes to be approved for a home equity loan. Another advantage is that the interest rate on many unsecured loans may be cheaper than the interest rate on credit cards.
Disadvantages of Unsecured Loans
Since unsecured loans are riskier for lenders because there is no collateral attached to it, the interest is usually higher than a secured loan, such as a mortgage. For this reason, the loan amounts are smaller and the terms are generally shorter than secured loans. Keep in mind that, although lenders can’t take your house or car, they can take other collection actions. This includes reporting late payments to the credit bureaus, hiring a collection agency, and filing a lawsuit against you.
Since lenders gain nothing if you fail to repay the money you borrowed, they tend to base their lending criteria on your creditworthiness. It is generally difficult to get approved for an unsecured loan if you have a bad credit score, but some lenders will allow you to borrow if you have a co-signer with excellent credit.
Consider Your Options
Before taking out an unsecured loan, research and decide which type of loan is best for your situation. For example, you may want to compare the differences between a payday loan and a personal loan.