As of the third quarter of 2021, the outstanding personal loan balance in the U.S. was $436.18 billion. People use personal loans for various reasons, including funding vacations, beginning home renovation projects or consolidating debt. Personal loans have become one of the most popular forms of consumer lending.
There are various personal loan types, including unsecured, debt consolidation or co-signed loans. MoneyGeek’s guide explores which personal loans to avoid. Understanding the different types of personal loans and their risks can help you avoid falling into a debt trap or having to file for bankruptcy.
Most personal loan types are helpful to borrowers, but some bring more risks than benefits.
Some personal loan types to avoid are cash advance apps, credit card advances, payday loans and pawnshop loans.
There are multiple disadvantages connected to some types of personal loans, like high interest rates and other associated fees.
Cash Advance Apps
You can download a cash advance app from the Google Play Store or the Apple App Store, making them highly available to borrowers. In a matter of minutes, you can have Earnin, Brigit, Empower or MoneyLion on your phone.
This option has become popular with consumers since it’s a convenient way to borrow money. Most allow you to borrow an amount against your next paycheck. Because these apps are aimed at those who receive regular wages, they might not be as helpful to freelancers.
While most lenders use credit scores to determine whether or not you qualify, cash advance apps typically require you to link to a bank account, prepaid debit card or mobile payment service. Doing this allows the lender to automatically deduct your loan amount (plus interest, if any) once your funds come in.
Remember that each app is different. Some charge a monthly fee. Other apps only charge a fee per use. Some apps allow you to give tips. It’s smart to go through these cash advance apps' various features.
A cash advance app can help you address financial challenges if you need emergency funds and payday is several days away. However, it may not be the best option if you do it monthly.
Downloading a cash advance app may sound like a fast and easy solution when you need emergency funds, but there are several reasons why avoiding this type of personal loan might be a wise choice.
- Encourages unhealthy financial habits: Continuously using a cash advance app turns it into a crutch. After all, it's easier to turn to it instead of developing a better budget or establishing an emergency fund.
- Triggers a vicious borrowing cycle: Deducting something this month (regardless of the amount) almost 100% guarantees that you'll fall short again next month, requiring you to borrow once more.
- Customer support might not be as accessible: Immediate customer support becomes essential if you encounter problems. Unfortunately, some cash advance apps only provide an email address as a service support line.
Although cash advance apps are a type of personal loan to avoid, you can employ several strategies to minimize your risk. Here are some tips for using your cash advance app wisely.
- Start building an emergency fund: Set an amount aside each month. You don’t have to start big, but establishing this habit ensures you’ll have something to dip into if you have unforeseen expenses.
- Do your research: Read up on what each cash advance app offers. You can check a brand’s rating from the Better Business Bureau to see how reputable the brand is. Reviews are also an excellent source of information — learning about other users’ experiences is always helpful.
- Save it as a last resort: Check other possible channels for borrowing before deciding on a cash advance app. You can seek out financial advice to see whether a different type of personal loan is in your better interest.
Credit Card Advances
Another type of personal loan to avoid is a credit card advance. It is a short-term loan offered by your credit card issuer. Like other loans, you will have to pay interest, which is typically higher than your card’s APR.
One reason people use credit card advances is convenience. The average American has three to four credit cards, and there’s no approval process for an advance, so as long as you have a credit card, you can use this option.
Unlike applying for an unsecured personal loan, you don’t need a credit check or to show proof of verifiable income. All of that is done when you first apply for your card. You don’t need to ensure you have money in your bank account since the amount you borrow is taken against your credit limit.
You can also get your funds in several ways. Credit cards with PINs allow you to get your advance through an ATM. If you don’t have a PIN, you can always contact your issuer and request one. Although it might take a couple of days to get, it’s often faster than furnishing the paperwork for a standard personal loan.
Another option is to go to your bank and request the advance in person. Some credit cards also send convenience checks. You can write one to yourself and cash it.
Getting a cash advance using your credit card is convenient, easy and fast. However, there are several reasons it’s part of MoneyGeek’s list of personal loan types to avoid.
- High interest rate: The average interest rate for credit cards is 14.56% as of the second quarter of 2022. Rates for credit card advances are typically higher than that.
- Presence of other fees: You pay a fee each time you make a cash advance — either a specific amount or a percentage of what you borrow. If you get your funds through an ATM, there are fees associated with that as well.
- It may affect your credit score: A credit card advance increases your credit utilization, which makes up 30% of your credit score.
If you pursue this personal loan type, keep the following in mind. These tips can help you manage your credit card advance well.
- Don’t borrow more than you need: Considering the APR, determine how much you need and try to avoid borrowing a higher amount. The more you borrow, the more you’ll have to pay (with interest).
- Pay it as soon as possible: Credit card advances don’t have grace periods, so your loan accrues interest the moment you process it. The longer it takes to pay your loan, the more interest you’ll need to pay.
- Compare credit cards: The best credit card for a cash advance will depend on your profile and needs. It’s smart to compare what each issuer offers and see which offers the best deal.
Despite the bad press payday loans receive, as many as 12 million people use them annually. They are highly accessible, with over 23,000 payday stores in the U.S. Consumers who need help paying essential expenses often consider using payday loans.
You might find a payday loan attractive if you don’t have enough cash and need a quick way to obtain funds to cover rent, food, utilities or medical bills. You can borrow small amounts — averaging around $500 — without undergoing a rigorous application process.
Payday loans are unsecured, so you don’t need to put anything up as collateral. They also don’t require a credit check. Technically, you only need to be age 18 or older, have an active bank or credit union account, a source of income and a valid ID to get this type of loan.
Despite the ease of getting approved, it’s wise to pause and consider the fallout. Payday loans are known for charging extremely high interest rates and giving borrowers a short time to pay the funds back. You may have to make a lump-sum payment on your next payday.
A payday loan is one type of personal loan to avoid. Here are several reasons you should be wary of this loan type.
- High interest rates: According to the Federal Reserve, the average interest rate for a two-year personal loan as of the first quarter of 2022 is 9.41%. In comparison, a payday loan may charge you up to 398% in interest, which you have to pay back in a short period.
- Unrealistic repayment schedule: Most payday lenders require you to pay in full after two weeks. Given the high interest rates, not all borrowers can do this. Those who can’t afford it typically borrow another amount, putting them deeper in debt.
- They may engage in aggressive debt collecting methods: You might start receiving multiple calls from debt collectors if you don’t pay your loan on time. It might begin to feel like they’re harassing you.
Although it may not be your best option, you might consider a payday loan. Before you proceed, it’s smart to consider a few points:
- Compare rates: Like other lenders, payday lenders offer varying rates. They’ll be higher than your credit card’s APR or standard personal loan rates, but a comparison can help you see your options.
- Look for alternatives: Paying debt by taking on more debt isn’t ideal, but a loan with lower interest rates and reasonable repayment terms might be a better option. It could be a manageable way to get funds to pay off your payday loan.
- Know your rights: Protect yourself by knowing what a lender can and cannot do. For example, a debt collector cannot contact you repeatedly to annoy or harass you. The Fair Debt Collection Practices Act prohibits collectors from calling you outside the hours of 8 a.m. and 9 p.m.
Unlike the other personal loan types we’ve covered, a pawnshop loan is secured. You’ll need to put something up as collateral to get your funds — in this case, a pawn. This can be any item of value. Jewelry, watches, mobile phones, laptops and TVs are popular picks.
The item you pawn correlates to the amount you can borrow. The more valuable it is, the higher your potential loan amount becomes. However, don’t expect the loan amount to be on par with your pawn’s estimated value.
Compared to traditional personal loans, pawnshop loans have few requirements, making them attractive. You won’t be required to fill out an application form or go through a credit check, which makes this loan type an option for individuals who don’t have good credit scores. You won’t even need to show proof of verifiable income.
The process is relatively uncomplicated. You’ll need to answer questions to verify you’re the item’s rightful owner. Once you agree on specifics, the pawnshop gives you a ticket with all essential information, like what you pawned, the loan agreement (including your interest rate, fees and finance charges) and when you’re supposed to pay.
You get your pawn back if you pay your loan on time. Otherwise, the pawnshop keeps it and has the option to resell it to compensate for its loss. You may have the option to extend your loan, but this comes with additional interest and fees.
A pawnshop loan can be a convenient answer to your cash flow challenge, but be aware that it may not be your best option. Before pushing through with this type of personal loan, here are some things to consider:
- Low loan amounts: The amount a pawnshop will lend you depends on your item’s appraised value. However, they will likely only offer to loan between 25% to 60% of its resale value.
- Higher interest: Rates vary between states. For example, pawnbrokers cannot charge more than 36% interest in Massachusetts. That’s higher than the average interest rate for credit cards (14.56%) and personal loans with a two-year term length (9.41%).
- You can lose your collateral: If you can’t pay your loan based on your agreement with the pawnshop, they’ll own your property. And you can’t stop them from selling it (usually for more than they loaned you).
If a pawnshop loan is something you’re considering, it’s smart to think about the following:
- Check their credentials: Choose a pawnshop registered in the National Pawnbrokers Association to ensure its legitimacy. You can also check their profile on the Better Business Bureau to see whether other consumers filed complaints against them.
- Choose your pawn wisely: Pawnshops offer higher amounts for items that have resale value to the general population. You may have spent a lot on your vinyl collection, but if they don’t think they can sell it quickly, you won’t get a good loan amount for it.
- Increase your income (at least temporarily): You typically have 30 to 60 days to repay your loan. You'll likely pay off your loan if you can increase your earnings within that period.
Frequently Asked Questions About Personal Loan Types
With the number of personal loan types available, it’s wise to consider which ones you may want to avoid. MoneyGeek answers the most commonly asked questions to help you decide.
- Experian. "The Average Personal Loan Balance Rose 3.7% in 2021." Accessed June 30, 2022.
- Experian. "What Is the Average Number of Credit Cards per US Consumer?." Accessed June 30, 2022.
- Federal Reserve. "Consumer Credit – G.19." Accessed June 30, 2022.
- FICO. "What’s in My FICO Scores?." Accessed June 30, 2022.
- PEW Charitable Trusts. "Payday Loan Facts and the CFPB’s Impact." Accessed June 30, 2022.
- Center for American Progress. "Young People are Payday Lenders’ Newest Prey." Accessed June 30, 2022.
- Debt.org. "Payday Loan and Lenders." Accessed June 30, 2022.
- Federal Trade Commission. "Fair Debt Collection Practices Act." Accessed June 30, 2022.
- Mass.gov. "Approved Pawnbroker Regulations and Interest Rates." Accessed June 30, 2022.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
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