Personal loans can be an excellent tool for securing financing at a fixed interest rate. Depending on your needs and goals, you can utilize funds from a personal loan to pay for a new home improvement project, consolidate high-interest debt, or give yourself a cash cushion if you can secure a favorable interest rate.
However, as there are many other personal lines of credit available to consumers, it’s important to understand how they operate so you can make the optimal decision for your personal finances.
Today we will compare personal loans to a variety of other credit lines, including credit cards and auto loans so that you will be prepared as you shop for new financing.
Who Can Benefit From Personal Loans?
Personal loans are a large segment of personal financing where the borrower receives a sum of money from a lender at a fixed interest rate.
For example, you could take out a $10,000 at a 6% interest rate for a 36-month term.
This means you would receive $10,000 from the bank or lender to spend on the project you requested financing for, you would be charged 6% interest over the 36-month term, and once you make your final payment, the loan account will close, and you will be finished paying it off.
There are other factors, including eligibility and approval from your lender, but the process is the same in most cases.
One of the primary benefits of personal loans is the predictable monthly payment coupled with a larger loan payment.
Imagine you want to add an enclosed porch to your home to increase its value, and you are deciding on how to pay for it.
- Paying in cash.
- Putting the project on a credit card.
- Financing it through a personal loan.
If the project is around $12,000, you may rack up an uncomfortable amount of interest on a credit card, and you may not want to part with such a large sum of cash.
This is where a personal loan can be very helpful because you can get the financing you need without worrying about cash flow or accruing too much interest.
Other Credit Lines
Now that we understand how personal loans work let’s look at some other types of credit to see how they compare.
While there can be some overlap in how the function of the loan, each type of credit line has unique features that lend themselves to their market.
- Credit Cards
Credit cards are the most famous personal credit lines because they come in many shapes and sizes, and most consumers have one credit card, if not more.
Credit cards are personal revolving credit lines offered by banks, credit unions, and other financial technology companies that enable the holder to spend money up to their limit and then pay it off entirely or over time with interest.
Revolving credit lines do not have a fixed payoff date, which means you can continue adding to your balance and accruing additional interest as time goes on. If you routinely pay off your credit card balance, you will avoid interest charges. But if you keep charging to your card without paying your balance, you may end up with a higher balance than you anticipated.
Mortgages are installment loans primarily used to finance a home purchase. The most common mortgage terms are 15 and 30-year mortgages with either a fixed or adjustable rate.
Fixed-rate mortgages allow borrowed to lock in the same interest rate for the duration of the loan, regardless of future market conditions. Adjustable-rate mortgages start with a below-market rate for a few years and then adjust to meet market rates.
There are pros and cons to each structure: fixed-rate mortgages can be a good choice in a low-interest rate environment because they will most likely not drop further, while adjustable-rate mortgages may be a good choice in a high-interest rate environment because your rate will go down if the market rates drop.
- Auto Loans
Auto loans are similar to personal loans because they have a fixed term and interest rate and will close out when you pay your final payment.
One of the major differences between the two loans is that auto loans are usually secured by the car being financed. For example, the lender can seize the car if a borrower misses defaults on an auto loan.
The benefits of auto loans include flexible terms and the ability to add gap insurance to your loan. Gap insurance helps protect your finances if your car gets totaled and it is valued at less than your loan balance.
Instead of going “underwater” on your loan, gap insurance will kick in and cover the difference.
Identify Financing That Works For You
There are plenty of reputable financing options on the market, so as you shop around for a loan, ask yourself what works with your budget and what type of loan will fit your project the best.
As you can see, personal loans are versatile and functional financing tools to help you get ahead on your finances.
If you want to learn more about personal loans and research some of the highest-rated lenders on the market, please check out our other guides and reviews.
* This content is not provided by the financial institution or the offer’s provider. Any opinions, analyses, reviews or recommendations expressed here are those of the author’s alone, and does not constitute a financial or expert advice.