How do personal loans work?

Let's say you've always had a goal of putting a pool in the backyard. You've started saving but won't have the amount you need for several years more. Then you see an ad for the pool company's 50th anniversary sale: For a limited time only, you could have the pool of your dreams at half of the original price! Book your consultation today!

The problem is you haven't saved enough even with the pool at half price.

In this circumstance, a personal loan could be the solution. However, there's more to consider than how quickly you might be able to get the funds you need. With an understanding of how personal loans work compared to other funding options, you can decide which one is best for you and avoid swimming in debt or regret.

Types of personal loans

A personal loan is an agreement between you and your bank or financial institution. They will provide you with requested funds up front and you agree to pay back that amount with interest within a certain period of time.

Personal loans can be an alternative to using a credit card to cover unexpected expenses or one-time, high-dollar purchases. There are two types of personal loans that you may qualify for, depending on lender requirements.

Unsecured personal loan

An unsecured personal loan means you don't need any collateral in order to qualify. For that reason, if you're unable to maintain repayments, the bank can't take anything away from you. However, your credit could take a big hit and you could be sent to collections, which can affect your financial standing.

Because an unsecured personal loan is a bigger risk for the lender than for the borrower, minimum qualifications to apply for the loan can be higher, such as a better credit score.

Secured personal loan

With this type of personal loan, the bank requires that the customer put up collateral that could be taken away if they aren't able to pay back the loan. Examples of collateral include money in a savings account or a physical asset like a vehicle. If your credit isn't in great shape, you may still qualify for a secured personal loan because the risk involved isn't solely the lender's.

Typically, personal loans have a fixed annual percentage rate, or APR. Factors that can affect APR include the amount of the loan and the length of the loan term. USAA Federal Saving Bank offers unsecured personal loans. You can get an estimate of your APR and monthly payment by using our personal loan calculator. It can also show you an estimate of how much you'd pay in interest overall.

Budgeting with a personal loan

With a fixed-rate loan, the monthly amount due will be the same until the loan is paid in full. This consistent amount can make it easier to budget for the length of the term, because there won't be any surprises about what you're expected to pay.

Some lenders may offer personal loans with an adjustable interest rate where the monthly amount due is subject to change based on market conditions. The variable rate might start out low and manageable before increasing and leading to a bigger monthly expense than you originally anticipated. If you're not sure you'll be able to keep up with unpredictable payments, this adjustable rate might do you more harm than good.

Reasons for personal loans

In a perfect world, you could save up to cover big expenses and avoid having to go into debt. In the real world, things don't always work out that way. Common uses for personal loans include:

• Home repair or remodeling. This can be unexpected and expensive. It's also often time-sensitive, depending on the availability of labor and materials.

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• Debt consolidation. This is where you use the personal loan to pay off other debts that may have higher interest rates, such as credit cards or other unsecured loans. This strategy can help reduce the overall number of debts owed and hopefully save you money by putting more toward the principal amount of the debt than you would put toward interest.

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• Emergency expenses. You may have unexpected medical bills or need to make a quick, necessary purchase like a new refrigerator when yours goes on the blink.

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If you need to get a loan for emergency expenses, make sure you prioritize saving for an emergency fund once the emergency is over. That way, when another emergency arises, you won't need to go into as much debt to pay it off.

Comparing personal loans and other options

Depending on the expense, your money management habits and your overall budget, a personal loan could be your best option. What it shouldn't be is a financial crutch to lean on for everything.

Other options are your savings accounts and credit cards. When you consider that the interest rate on a credit card is typically higher than that of a personal loan, using a credit card can easily lead you into further debt. However, if the minimum amount of a personal loan you can get is $2,000 and you only need $1,000, a credit card might be the answer.

You might even consider a home equity loan or line of credit, but be sure to understand the terms and conditions including what could happen if you default.

Your goal should be to provide for your project in the cheapest way possible, which means, paying the least amount of interest you can. That's why saving for the expense is usually best. You don't pay interest to anyone when you pay cash. But since that's not always feasible, analyze which option is best for you and has the least number of negative impacts to your financial security.

The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.