There are many good reasons to borrow money, and taking out a loan might be the only option when bills start stacking up. However, some types of loans tend to have such high fees or interest rates that they can leave borrowers in a debt cycle—continually borrowing more money to pay off debts. To avoid this trap, try to stay away from these five types of loans.
1. Payday Loans
Getting a payday loan can be quick and easy, but there are often extremely high fees and short repayment terms. For example, many payday loans are for $500 or less, need to be repaid within 14 days and charge a $10 to $30 fee for every $100 you borrow.
Although the fee might seem small, the short repayment term can make these loans difficult to pay off. The annual percentage rate (APR) for a $300 payday loan with a $45 fee and a 14-day repayment period is nearly 400%. By comparison, credit cards are often considered high-interest debt, and most have APRs under 30%.
You might wind up paying additional fees if you can't afford the full repayment by the due date and have to renew the loan. In some states, however, you can extend the repayment period without paying additional costs.
Look into different options if you're considering a payday loan. Some large banks offer small-dollar loans with better terms, and some credit unions offer payday alternative loans.
2. High-Cost Installment Loans
As a broad category, installment loans aren't inherently bad. With this type of loan, you receive the money upfront and repay it in installments, such as weekly, biweekly or monthly payments. Personal loans, mortgages, auto loans and student loans are all types of installment loans. However, some installment loans have high fees or interest rates, resulting in APRs over 150%.
You might find these loans online and at some retailers that offer financing. In general, the loans tend to be for as little as $500 up to several thousand dollars, with repayment terms ranging from a few months to two years. Although longer repayment terms can lead to a more manageable payment amount, the high cost can still leave borrowers deep in debt.
Many borrowers wind up refinancing their loans—taking out a new loan to pay off the current one. And, in total, you could end up paying more in fees and interest than you borrowed in the first place.
3. Auto Title Loans
Auto title loans let you quickly borrow money using the equity in your vehicle as collateral. You generally don't need good credit and might not even need to have an income to qualify—which can make them one of the few possible options if you're in a real pinch. However, these loans often have high costs and short repayment terms, which can make title loans a bad idea.
If you don't repay the loan on time, the lender might repossess your vehicle, which could have a cascading effect. These types of loans are actually illegal in many states, but you should be cautious even if they are allowed where you live.
4. Pawnshop Loans
A pawnshop loan lets you get a short-term loan by offering an item of value to the pawnshop as collateral. If you repay the loan, you get your item back. If you can't, you might be able to pay a fee to extend or renew the loan, or the shop can keep and sell the item.
Some pawnshop loans might charge reasonable fees or interest, which could make them an OK choice if you need money fast and don't qualify for any alternatives. However, the rates can depend on the shop's location, and the costs could be equivalent to a triple-digit APR in some cases.
5. Credit Card Cash Advances
You can use your credit card to get cash from an ATM, bank teller, online transfer or use a check tied to your credit card account. However, it's often not a good idea. Credit cards generally charge a cash advance fee—a percentage of the amount you request. The cash advance balance will also start to accrue interest immediately, potentially with a higher interest rate than your card charges on purchases.
Frequently Asked Questions (FAQs)
The best type of loan will depend on the circumstances. For example, if you need cash for a large purchase, a personal loan might be one of the best options, especially if you have good credit. However, if you own a home and have a home equity line of credit (HELOC), you'll want to compare pros and cons of using the HELOC versus taking out a personal loan.
When comparing different types of loans, consider the potential costs and the ramifications if you don't repay the loan. Once you narrow in on the type that you want to use, you can then try to get loan offers from several lenders to see who offers you the most favorable terms.
Personal loans don't require collateral, which is why your income and credit will be important factors in whether you qualify and the terms you receive. Generally, you need to have a good credit score to get a personal loan, such as a FICO® Score☉ in the high 600s.
The specific requirements will vary depending on the lender, and you might qualify for a personal loan from some lenders even if you have a lower credit score. But improving your credit score first might help you qualify for a larger loan, lower interest rate and lower fees.
You can improve your credit score by making loan and credit card payments on time and paying down credit card balances. Bringing past-due accounts current and paying off collection accounts may also help.
If you don't currently have any loans or credit cards, look into options for people who are building or rebuilding their credit, such as secured credit cards and credit-builder loans. You can also use Experian Boost®ø to add utility, rent and streaming service payments to your Experian credit report for free, which may lead to an immediate increase in your credit score.
Quickly Compare Loans Offers
Before taking out a loan that has a sky-high interest rate, see if you can get matched with a personal loan based on your unique credit profile using Experian CreditMatch™. It's a free way to quickly compare loan offers. You can also check your credit report and score for free, and get insights into what's affecting your credit score and steps you can take to improve your score.