How Do Bank Loans Work?

Learn about personal loans, auto loans and more so you can determine the right loan for you.

A bank loan might be the best solution when you need to borrow money to make a large purchase or to cover unexpected expenses. There are several different kinds of personal bank loans, such as auto loans and personal lines of credit.

Determining why you need the loan and how quickly you will be able to repay it can help you decide which type of loan is right for you. To save money over the life of the loan, take time to research and find the best personal loan rates.

What Are Bank Loans?

A bank loan is a sum of money you borrow from a bank or a credit union. The bank will issue the loan based on your credit rating and current ability to repay the loan. The loans can be secured — attached to collateral like a car — or unsecured. The monthly payments will go to the bank, and the interest rate is usually determined by your credit score.

Different Types of Bank Loans

There are a variety of personal loans available through banks. If you are buying a car, you will apply for an auto loans. If you need money for other reasons, you might apply for a personal line of credit. If you want to access the equity in your home, you might take out a line of credit against your home, called a home equity loan. These all tend to be secured loans. Banks might also offer unsecured personal loans. Credit unions typically offer the same types of loans, sometimes at lower rates.

Related: 10 Best Credit Unions for Car Loans

How Bank Loans Work

To understand how bank loans work, familiarize yourself with these key terms:

  • Secured vs. unsecured loans: Secured loans are attached to some type of collateral. For example, your car is collateral for an auto loan. If you fail to make payments, the bank can take your car. Unsecured loans are not attached to any collateral. Unsecured loans might be more difficult to qualify for a loan with poor credit, and the annual percentage rate, or APR, might be higher as a result.
  • Rate: Loans have either a set or variable interest rate depending on the loan type, bank and your credit rating.
  • Term: The loan term is how long you have to repay the loan in full. An installment loan has a set number of payments, whereas a revolving credit account requires you to pay off a percentage of what you owe each month.

Loan Eligibility

To qualify for a loan, you must meet basic eligibility requirements. The bank will look at your personal credit history, credit score, the amount of debt you currently owe and your payment history. Banks will consider how much you currently make compared to your debt load with your new loan. If you owe too much money, you might not be approved for a new loan.

Loan Application Process

The bank will require you to complete a loan application, usually online or in person. Generally, the bank will need your Social Security number, address, employment information and income and other financial information. The bank might also verify that you are a citizen of the United States. For an auto loan, you will need to provide the information about the car and proof of insurance. After you apply, the bank will consider the information and look at your credit report to determine if you qualify for the loan.

Bank Loan Repayment Process

Many bank loans are installment loans, which are repaid by making monthly payments on a set schedule. These payments are the same amount each month. The interest is paid each month and slowly decreases over time.

If you want to pay off your loan more quickly, you can pay extra payments to the principal of the loan, which will reduce the amount you pay in interest over the life of the loan. For a line of credit, you will make a minimum payment based on the amount you currently owe. Some banks charge penalties for paying off a loan too soon, so be sure to check the terms and conditions for this information.

Up Next: How to Choose Between Secured and Unsecured Credit Cards