How Do Bank Loans Work and What Do You Need To Qualify?
Written by
Karen Doyle
Edited by
Melanie Grafil
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Bank loans are a way for people to get the money they need. Getting a loan from a bank isn’t difficult, but there are some steps you need to take.
- Choose the bank you want to apply to. A bank you already do business with may give you a slightly better rate.
- Fill out an application. You can usually do this online or in person at a branch.
- Provide proof of your income, such as pay stubs or your tax return.
- Agree to a credit check.
- Wait for approval from the bank. This may take a few hours or up to several days, depending on the bank’s policies and the amount or complexity of the loan.
- Sign a loan agreement — read it first — and get your money, either as a check or by direct deposit.
Here’s what you need to know about how bank loans work and what you need to qualify for one.
Types of Loans You Can Get From a BankÂ
There are several different kinds of loans you can get from a bank. They vary depending on the purpose of the loan. While they all work in pretty much the same way, the terms may be different.
Here are some examples:
Mortgages
A mortgage loan is used to buy a home. Interest rates on mortgages are typically relatively low since the bank has a claim on the home until you pay it off. If you don’t pay, the lender can foreclose and sell the home to recoup the money they loaned you.
Auto Loan
An auto loan is used to buy a car or other vehicle. Similar to a mortgage, an auto loan is secured by the vehicle. The lender will keep the title until the loan is paid off.
Personal Loan
A personal loan can be used for nearly any purpose. It’s usually unsecured, meaning that there is no collateral like a home or a car. For that reason, interest rates tend to be higher and qualifications more stringent.
Business Loan
A business loan can be used to start or grow a company. To qualify, you will need to present a business plan and financial statements, if the business is currently active. It may be secured by the business’ assets.
Home Equity Loan or Line of Credit
A home equity loan or line of credit is a loan against the equity in your home. It’s like a mortgage, but you can qualify if you already have a primary mortgage. It’s often used for home improvements and is secured by the home, just like a primary mortgage.
Here’s a comparison of the different types of loans.
| Loan Type | Purpose | Collateral Required? | Typical Term Length |
|---|---|---|---|
| Mortgage | Buying a home | Yes, the home itself | 15 to 30 years |
| Auto loan | Buying a new or used vehicle | Yes, the car itself | 3 to 6 years |
| Personal loan | Debt consolidation, emergencies | No | 1 to 7 years |
| Business loan | Start or grow a business | Sometimes | 1 to over 10 years |
| Home equity loan | Major expenses, renovations | Yes, the home | 5 to 15 years |
| HELOC | Having flexible cash | Yes, the home | 10-year draw, 20-year repay |
Personal Loan vs. Line of Credit
A loan is a one-time lump sum, while a line of credit can be drawn on as needed.
What Do Banks Look For When You Apply?Â
When you apply for a loan at the bank, they want to be sure you’re going to pay it back. There are several things they look for to be confident in their decision.
- A good credit score: You’ll typically need a score of 670 or higher to get a good interest rate.
- Proof of income: You’ll need to show pay stubs, tax returns or bank statements to show how much you earn. A steady work history is also a plus.
- Low debt-to-income ratio: Banks prefer that the cost of your total debt is 35% or less of your income. This includes your mortgage payment.
- Identification: The bank will ask you for your social security number and will ask to see government-issued identification like a driver’s license or passport, even if they know you.
- Collateral: If you’re applying for a secured loan, like a mortgage, home equity loan, vehicle loan or some business loans, the bank will want an appraisal of the collateral.
How Do You Pay Back a Bank Loan?Â
The payment schedule should be outlined in your loan agreement, so make sure you understand it.
You’ll make monthly payments until the loan is paid off. Each payment will consist of a part of the principal of the loan plus interest. In most cases, the amount is the same each month, but your agreement should say if this is not the case.
If you want to and are able, you should be able to make larger payments to pay the loan off earlier. This will save you some money in interest. Check your loan agreement to make sure there isn’t a prepayment penalty if you want to do this.
Pros and Cons of Getting a Loan From a BankÂ
A bank isn’t the only place where you can get a loan. You can try online lenders. You can even ask friends or family. Take a look at the pros and cons of getting a loan from a bank vs. somewhere else.
| Pros | Cons |
|---|---|
| May have lower interest rates than other lenders | It may be harder to qualify with bad credit |
| Trusted, regulated institutions with legally binding terms | It may take longer than online loans |
| In-person help is available | There may be more paperwork or stricter terms |
When Should You Consider a Bank Loan?Â
Taking on debt shouldn’t be done lightly. There are times when it makes sense to consider taking a loan from a bank. This is when you should consider a bank loan.
Major Purchases
You are making a large purchase like a home or a vehicle. These are things most people cannot buy with cash, so a bank loan is a smart choice.
When You Need a Set Amount
You need a specific amount of money that you can repay over time. The money can be used for just about anything, but remember you are paying for the use of the money, so make sure whatever you’re using it for is worth it.
Pay Off High-Interest Debt
You have high-interest debt you want to pay off. If you’re paying 25% interest on credit cards, taking a bank loan at 10% interest and paying off your credit cards with the proceeds makes sense. Just make sure you don’t rack up those credit cards again.
FAQs on Bank Loans
Curious about how bank loans work? Learn more from these questions that people ask before borrowing.- What is a bank loan?
- A bank loan is when a bank gives you a lump sum of money, which you then pay back, with interest over time.
- Can I get a bank loan with bad credit?
- If you have bad credit, you can still get a bank loan. Banks have varying standards for the credit score they require for a loan. If your credit is poor, you'll likely pay a higher interest rate than someone with excellent credit.
- How long does it take to get a bank loan?
- The amount of time between applying for a loan a receiving the money can vary, but usually ranges from a few hours to several days. Some loans, like business loans or home equity loans, can take longer, as they require more documentation.
