Personal loans are a type of credit you can apply for from banks and other lenders, but they differ from credit cards, Buy Now Pay Later (BNPL) services, payday loans, and line of credit loans. The main difference is the size of the loan, the interest rate, and the repayment obligations.
Compared to other types of credit, a personal loan:
- Is typically used for larger lump sum expenditures, with a fixed loan size between $4,000 and $50,000, which is paid off in around one to seven years. BNPL has an upper limit of $2,000, and payday loans range from $2,000 to $5,000 (and coming with shockingly high interest rates). A line of credit is similar to a credit card—you apply for a credit limit and can access funds as and when needed over time—provided you keep paying down the balance.
- Usually attracts a lower interest rate—starting in the single digits—whereas credit cards and a line of credit often attract rates in the 10 % to 25% range. As mentioned, interest rates on payday loans are notoriously high (rates are capped at 48% per annum) and fees associated with ‘interest-free’ BNPL can be exceptionally steep, especially if you’re late on repayments.
- Comes with a structured repayment schedule where you must pay back a set amount every week (or fortnight or month) to avoid going into arrears. You may be charged for making extra repayments or even for paying your loan off too quickly.
Personal loans are less flexible than revolving credit, but they also give you a longer time to pay off your purchase at what is generally a more affordable interest rate than alternatives.
Types of Personal Loans
Just like a home loan, you’ll pay interest on the repayments you make on your personal loan amount, and you’ll need to prove you can afford it when you apply.
Personal loans can have either a fixed or a variable interest rate, and be secured or unsecured.
- Fixed: Locks-in a specific interest rate for the duration of the loan, so you know exactly what your repayments will be. Some fixed loans include a fee for paying off your loan earlier than the expected term, sometimes called an ‘exit fee’—check the conditions offered by the lender if you’re hoping to make extra repayments.
- Variable: Means your interest rate may change (e.g., when the central bank cash rate rises), which means your repayments could increase or decrease over the term of the loan. Variable loans are often more flexible in terms of allowing extra payments and redraws.
- Secured: You can potentially get a better interest rate by putting up a car or home as collateral in case you default on your loan repayments (this can include the car you’re using the loan to buy). For secured loans, you’ll usually be able to use any asset of equivalent value as security.
- Unsecured: No need to offer any other asset as security. Because the risk to the lender is higher, unsecured loans often have a higher interest rate than a secured option. Unsecured loans can be easier to apply for, since you won’t need to provide proof of a suitable asset to be used as security.
Another option for securing a personal loan—especially for young people with no credit history, or people with a poor credit score—is a guarantor personal loan. That’s when you ask a parent or a friend to become a guarantor, which means they commit (and risk) their asset as security on your behalf or become liable for repayments if you default.
