Financial Answer Center

There are many different types of personal loans that you may be able to obtain. Personal loans, or consumer loans, may be the least favorable way to borrow money, since they may carry higher interest rates, and the interest you pay on the loans is not tax-deductible. Personal loans include secured and unsecured loans.

Secured Loans

Secured loans are loans that are guaranteed by some form of collateral. Here are some common types of collateral:

• automobiles and trucks
• shares of stock
• boats and recreational vehicles
• savings accounts

Interest rates vary with the type of loan, the amount, and the term of the loan. Because you have put up an asset as collateral, the rate is usually lower than if you do not put up any collateral.

A lender will perform a credit check before approving a consumer loan. If you do not have a good credit rating and you don't already have a reputation established with the lender, you may be required to have a co-signer on the loan. A co-signer will be obligated to pay the loan if you should default.

Unsecured Loans

An unsecured loan is issued on the basis of your credit rating only. Since the lender doesn't have a claim to any of your assets if you should default on the loan, this is a riskier proposition for the lender than a secured loan. Therefore, the interest rates are usually higher than with a secured loan.

Credit Cards

Credit cards are a common type of unsecured loan or line of credit. Using credit cards as a source of funds for borrowing is almost always an expensive option. Rates are generally higher than for other loans, and because you are only required to pay a minimum balance each month, debt can mount up very quickly.

All credit cards are not created equal. Interest rates charged on each card will vary, and in addition some have annual fees (which also vary). Expect to see trade-offs—cards with no annual fees sometimes charge a higher interest rate.

You may get a credit card offer with a very low annual rate, combined with a suggestion that you consolidate other high-interest credit card debt into this account. This can be financially beneficial if you make every payment to the new account on time. If not, you may find that your new, "low-rate" credit card has suddenly ballooned into rates equal to or exceeding the rates of the accounts you consolidated.

SUGGESTION: Pay close attention to the due date on your credit card statement, and if mailing your payment, make sure you put every payment into the U.S. mail at least seven business days before the due date. If the credit card company receives the payment even one day late, they will assess a late payment fee, and may increase your interest rate. Online bill payment is a convenient way to pay your bills, and in many cases, payments are sent electronically to the credit card company the next day.

Watch also for the "grace period." This is the amount of time you have to pay the bill without incurring a finance charge. Always look for a 25- to 30-day grace period. Some credit card companies also offer incentives, such as discounts on purchases or frequent flier miles. Take these incentives into consideration when selecting your credit card company.

Get into the habit of reading the fine print. Not all credit card issuers compute their interest charges the same way. There are various methods for calculating how much interest accrues on your outstanding credit card balance each month. Each method yields a different result, either more favorable to you (see below) or to the lender.

How Do You Know What Card to Choose?

If you pay your credit card balance in full every month:

• Getting the lowest interest rate should not matter to you.
• Make sure you get a no annual fee card.
• Look for incentive programs, such as cash-back reward programs.

If you carry a monthly balance:

• Get the lowest interest rate you can find.
• Make sure you get a no annual fee card, but concentrate on a low interest rate first.
• Try to find a card that computes interest using either the average daily balance method (excluding new purchases) or the adjusted balance method. These methods work out most favorably to you, the borrower. Watch out for the two-cycle average daily balance method, which can result in higher interest charges.

IMPORTANT NOTE: If you are offered a credit card with a low introductory "teaser" rate, be sure you know what the interest rate will be after the introductory period is over. If not, you may be in for a surprise.

Credit Card Liability

Federal consumer protection laws protect you against unauthorized use of your lost or stolen credit card. If this happens to you, you will only be liable for up to a maximum of $50 of fraudulent charges against each card. But guard your card carefully; the work involved in clearing up a fouled credit card may not cost you much money, but you will surely make up for it, in headaches! Also see the section Managing Your Credit and Debt.

Debit Cards

With a debit card, you make a purchase using a card that is electronically tied into the computers of your bank and the merchant's bank. The transaction automatically transfers cash out of your bank account and into the merchant's account equal to the amount of the purchase. No credit is extended. If insufficient funds are on hand to complete the transaction, the bank may automatically extend credit at that time, but that varies with each individual arrangement. A summary of your transactions appears on your monthly bank statement.

If you use a debit card, it is important to keep receipts, and enter the transaction as soon as you can into your check register. Otherwise you could have unpleasant surprises when you next try to reconcile your account balances!

Overdraft Checking

Overdraft checking, also known as reserve checking, is a line of credit on your checking account. The bank will advance you money in your checking account in case you write a check over and above the account balance. The line of credit is usually not too high. But be careful: if you make it a habit, you will wind up paying quite a bit in interest charges, and debt will accumulate quickly. Avoid using it as a source of funds.

IMPORTANT NOTE: Your overdraft checking is designed to function as a source of funds only if you inadvertently bounce a check or temporarily need a small advance of money. You shouldn't view it as a source of long term borrowing. Also, there may be fees involved when using overdraft checking.

IMPORTANT NOTE: Remember that interest is not tax-deductible for any type of consumer loan.