By Sabrina Karl
Mortgages, auto loans, and credit cards have become familiar financing tools for many Americans. But fewer of us have experience with personal loans.
Personal loans are a cross between a mortgage or car loan and a credit card. Like a credit card, you can use the money for whatever you like. Also like a credit card, personal loans are unsecured, meaning there is no collateral—like a house or vehicle—to backup the lender in case you default. As a result, the interest rates on personal loans are higher than on secured loans.
Personal loans are structured more like home and auto loans, though. Whereas credit cards offer a revolving line of credit you can use and pay off at various amounts over time, personal loans provide a fixed amount of funds that are repaid in uniform monthly payments over a set loan term.
The lowest personal loan rates are currently around 6%, though they range into the double digits. And though term lengths vary, the most common run from 2 to 7 years.
So when is a personal loan a good idea? A top reason is to consolidate other, more expensive debt. If you can score a personal loan rate substantially lower than what you’re paying elsewhere, it can be smart to use one to pay off those high-rate obligations.
Personal loans are also useful for those who can’t get lower-rate credit. Opening a credit card with a 0% or low promotional rate can be a better option financially, but not if you can’t qualify for one of those.
It’s generally advised, however, to refrain from using personal loans for big-ticket items that are discretionary and beyond your budget, like a bigger wedding than you can afford or travel that you’re better off deferring until you can save up enough funds.