The different types of personal loan can significantly change the costs involved and what is needed from you in order to be approved for a loan. It’s important to weigh up which is best for you.
Fixed- vs variable-rate personal loans
Personal loans have two interest repayment types, fixed and variable. Both have different features that will influence whether they are suitable for you.
With a fixed-rate personal loan, the amount you pay in interest is set from the beginning of the loan through to completion. This means your weekly, fortnightly, or monthly repayments remain the same. When you choose a fixed interest rate, you benefit from being able to lock in a competitive rate with the security of knowing your repayments will remain steady regardless of changes in the market. This is a useful feature when managing a budget.
Fixed-rate loans do, however, tend to attract a higher rate of interest than the current variable rates on offer. That being said, when interest rates are already low, locking in a fixed rate can protect you from any future rate increases due to changes in the lender's funding or the the broader economy.
Why choose a fixed interest personal loan?
+ Repayments are set for the duration of the loan + Easier to maintain a budget – Early repayment or exit fees are more common – Less flexibility when it comes to repayments
With a variable-rate personal loan, the interest rate can change or vary over the life of the loan. Variable interest rates can change for a number of different reasons (e.g. market changes, cost of funds etc.) and can vary between loan providers. When rates move down, you as the borrower benefit from lower repayments. When rates move up, you will need to be able to cover the added costs. To account for this uncertainty, variable-rate loans have a lower starting price than their fixed-rate counterparts.
Want greater flexibility or are hoping to pay your loan back early? Variable-rate personal loans often have fewer repayments restrictions than fixed-rate loans, so you can make additional repayments and repay your loan early without getting charged an early repayment fee.
Why choose a variable interest personal loan?
+ Greater flexibility to repay your loan early, often without fees + Benefit from any reduction in interest rates + Interest rates are generally lower – Potential for rates to move up significantly
Finally, it’s worth remembering that the rate you may be offered on a personal loan may be higher than the advertised fixed or variable rate. The lender will usually decide your interest rate based on your credit score, income, expenses, and assets. So, whilst the variable option may seem more favourable initially, once you’ve received a personalised rate estimate, a fixed-rate personal loan may have a lower rate, and vice versa.
Secured vs unsecured personal loans
If you own an asset like a car, home or term deposit, you may be able to access a lower interest rate with a secured personal loan. With a secured loan, your asset(s) will be put up as security for the loan. This means that as part of your loan approval and acceptance, you will grant the lender rights over the asset, usually in the form of a mortgage, caveat or charge. In the unlikely event that you are unable to make your repayments, the rights granted to the lender will allow them to seize the asset(s) and on-sell them so that the outstanding debt can be repaid.
Because of this, lenders view secured loans as less risky and therefore are willing to offer a lower interest rate. Having an asset-backed loan may also allow you to borrow a larger amount or for a longer period than would be available to you if the loan were unsecured.
Some secured loans have special rules that impact what or how you can use the funds. For example, a secured car loan may place restrictions on the type of car, whether it is new or used, or the maximum age of the car being bought. This is to ensure that the asset's loan to value ratio (LVR) is sufficient to cover the outstanding value of the loan in the event of default.
Why choose a secured personal loan?
+ Lower rates on offer + Increased borrowing capacity + Longer loan terms available – Potential to lose the asset if you are unable to repay – Longer approval process and requirements – May have restrictions on what funds can be used for
Whilst there are benefits to a secured loan, the vast majority of personal loans are unsecured. With an unsecured personal loan, no assets are used as security against the loan. In this case, a lender’s decision to provide you with a loan is based solely on how creditworthy you are. Put simply, are you more or less likely to make your repayments on time or default on the loan? As a result, choosing an unsecured loan may result in a higher interest rate or lower loan amount being offered.
Why choose an unsecured personal loan?
+ Quicker application and approval process + Greater freedom in the use of funds + Your assets are not directly at risk – Interest rates can be higher – Your borrowing capacity may be lower – May only be eligible for shorter loan terms
Fixed-term personal loan vs a line of credit
Fixed-term personal loans work well where you have a specific one-off purchase to make or defined expenses to pay, such as buying a car or paying for a wedding or holiday. They also attract lower interest rates than lines of credit, while providing you with the confidence that comes from having a predictable repayment schedule. Having a defined start and end date also ensures you are committed to repaying the debt and you are repaying the principal amount of your loan.
If it's flexibility you are after, some personal loan providers offer top-up, redraw or second loan options for borrowers.
A ‘top-up’ is where you add an additional amount to your existing loan. This will result in a change in your repayments and can sometimes result in a resetting of your loan term. It remains one loan, with a single repayment schedule for your convenience.
A ‘redraw facility’ allows you to make early repayments on your personal loan. The early repayments create a buffer between the actual amount you have repaid versus the amount that would have been outstanding on your loan original repayment schedule. This buffer is the amount you are able to withdraw at any point during the loan. In this case, your repayment schedule and amount remain the same.
Some lenders may be willing to offer you a second loan while your original loan balance is outstanding. To qualify, you will need to have maintained an impeccable repayment record (i.e. no missed payments in the last 12 months) as well as be able to demonstrate you can service a second loan (e.g. you have surplus income after your existing expenses). Different lenders have different credit policies, so it pays to do your research.
Why choose a fixed-term personal loan?
+ Know how much you are borrowing and repaying + Fixed repayment schedule + Lower interest rates + Better if you are less disciplined with your spending – A single lump sum may be more than you need – Less flexibility
A line of credit is a type of personal loan that works like a credit card. It allows you to draw on funds in the form of an ongoing credit facility. You pay off the debt and accrued interest in instalments, in the meantime, you can access a set amount of extra funds as you need it.
Unlike a personal loan where you get one big lump sum, a line of credit gives you a credit limit but the funds stay where they are until you withdraw them. The advantage here is that you only pay interest on the money that you actually use versus the entire amount as would be the case with a personal loan. Generally, a line of credit loan is useful if you need ongoing access to money but don’t know yet exactly how much. Some lenders provide a debit card for this.
Lines of credit offer the benefit of having ongoing access to money to spend as you wish or in case of emergency. A word to the wise: if you get tempted to spend just because you can and lack the discipline to make full payments on time, the higher interest from a line of credit can add up quickly. These loans usually come with numerous fees and charges.
Why choose a line of credit?
+ Access to funds as you need them + Only pay interest on the outstanding balance + Ongoing access to funds – Higher interest rates if you don’t repay in full – Higher fees – Risk of overspending with ease of access to funds
Special purpose personal loans
Some lenders offer personal loans with lower interest rates provided the funds are used for a specific purpose.
A green loan is an unsecured personal loan that you can use to fund the purchase and installation of approved renewable energy products (like solar panels or home batteries). These products can help significantly lower your power bills and the cost of the loan can potentially be offset by the power savings alone.
Green loans have specific criteria that may vary by lender. This may include the types of renewable technology covered, all the way down to the brand, make and model of device being installed. In order to facilitate this, the majority of green loans are offered at the point of sale by a fully accredited renewable energy installer from a list of pre-approved products. The accredited installer will assist you with your finance application and once your products have been installed, the lender will pay the installer's invoice directly.
A Plenti Green Loan ranges from $2,000 to $50,000 and 3 to 7 years, however, the average loan size is around $8,000 to $12,000.
Market Insight. Plenti is the largest provider of interest-bearing renewable energy loans for consumers in Australia. As of March 2021, Plenti has lent over $120 million toward solar and home battery installations.
Repairing, remodelling or revamping your home can be a great way to add to the value of your property. Some lenders offer specialised loans for home renovations. These can be secured or unsecured and may attract a lower rate of interest than a standard unsecured loan.
To qualify for this lower rate, however, there may be additional costs (e.g. fees for registering mortgages or charges over secured property) and information requirements (e.g. detailed quotes, council approvals and valuations). There may also be restrictions around the use of funds, for example, some lenders will pay the borrowed amount directly to the provider(s), making it a less flexible option than a traditional personal loan.
It is now more common for lenders to give a ‘personalised’ interest rate and tailor the loans offered. This is achieved through ‘risked-based’ pricing, where the rate provided is based on the probability of a borrower defaulting on a loan. The lender will calculate this by looking at your credit history, financial situation, loan type, loan amount and a range of other factors that are used to build your unique risk profile. If you are deemed ‘low-risk’ and more likely to pay back the loan, you’ll be rewarded with a lower rate, and ‘higher risk’ with a higher rate.
In the past, risk-based pricing wasn’t common in Australia, mainly because credit reports only showed negative credit events or ‘black marks’ (e.g. missed payments or defaults), rather than giving an overall picture. With the introduction of comprehensive credit reporting (CCR) credit providers are now required to include extra ‘positive’ information such as the type of credit you hold, the amount of credit and whether you pay your bills on time.
Most lenders will provide you with a rate estimate or quote before you go through their online application process (which does not affect your credit score). From there you should be well placed to compare the features and benefits of each loan.
What is my credit score?
Based on the information in your credit report, your credit score, or rating, is a single number that sums up how risky – or trustworthy – you are as a borrower. Credit scores are typically on a scale of 0–1,200 or 0–1,000 depending on the credit agency you use. The higher your credit score, the more ‘reliable’ you are perceived to be and the greater the likelihood of your loan being approved.
Now that the industry uses comprehensive credit reporting (CCR), credit reports are more detailed so that lenders have a better picture of both the positives and negatives. To calculate your credit score, credit agencies will assess:
How much money you’ve borrowed in the past
How much credit you currently have
How many, and what type of credit applications, you’ve made (this can now include payday loans and buy-now-pay-later services such as AfterPay)
Whether you pay on time
Any loan defaults
Information from your bank, telco, insurance and utility companies
Your age, address and employment situation
Up to two years of your general financial history
You can request your report and rating/score from credit rating agencies before you go through and pay for the application process. This does not impact your credit score. Be aware that because there are multiple credit agencies, the information your lender uses may not be exactly the same.
Get your free credit check from one of Australia’s major credit rating agencies: Equifax, Experian or Illion.