What Is a Personal Loan?

©iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

A personal loan is money you borrow from a bank, credit union, or online lender, usually paid back in monthly installments. Most personal loans are unsecured, meaning you don’t need any collateral like a savings account or property to secure the funds you borrow.

How Do Personal Loans Work? A Simple Guide 

Personal loans typically have a fixed repayment schedule, often two to seven years, though some shorter and longer terms are available as well.

Paying Interest

When you take out a personal loan, you’ll pay interest as part of your monthly payment installment. The lender will decide upon your interest rate when reviewing your loan application, which will include financial details like your income and credit score. Most personal loan interest rates are fixed, meaning they stay the same over the entire loan term.

Regular Payments

Once you take out a personal loan, you’ll repay the lender over time in regular monthly payments. For instance, if you borrowed $5,000 with a term of 24 months, your monthly payment would be about $208, before factoring in your interest.

What Is Needed for a Personal Loan?

If you’re wondering how to get a personal loan, you should first familiarize yourself with the application requirements. You’ll need to gather the following to prepare your application:

• Proof of identity, such as a government-issued ID
• Proof of income and employment, which can include pay stubs or tax returns
• Proof of address, such as utility bills
• Credit score — you’ll submit to a hard credit inquiry when you apply for a personal loan. You should know your credit score before you apply, and check if the lender has a minimum credit score.

What Are Personal Loans Used For? 

Most personal loans can technically be used for anything. Here are some examples:

• Debt consolidation
• Emergency expenses like medical bills, home renovation
• Milestone events like a wedding

You can even use a personal loan for business purposes, which can be a good option if you can’t qualify for a business loan because you’re just starting out and don’t have much to show in the way of a business credit score or revenue.

While most personal loans are multipurpose, meaning you won’t specifically apply for a wedding loan or a debt consolidation loan, a lender may ask you how you’re planning to use the loan as part of the application process.

How To Get a Personal Loan 

To get a personal loan, follow these steps.

1. Check your credit score: Knowing your credit score ahead of time will help you know if you meet lenders’ requirements.
2. Compare lenders and rates: Lenders offer a variety of rates and terms, so it’s essential to compare multiple options to secure the best deal.
3. Prequalify if possible: Some lenders allow you to prequalify by sharing some basic financial info, which can give you an idea of how much money you can borrow without undergoing a hard credit pull, which can cause a dip in your credit score in the short term.
4. Gather needed documents: As mentioned above, you’ll need to provide proof of identity, income and more.
5. Submit your application: You can either apply online or in person, depending on whether you go through a bank, credit union or online-only lender.
6. Get approved and receive funds: Some lenders offer same-day approval, while others take a few business days to approve your application and deliver your funds.

Types of Personal Loans 

There are many types of personal loans, reflecting the fact that you can use them in a variety of ways. Here’s a breakdown of the most common varieties.

Unsecured Personal Loans

Most personal loans are unsecured, meaning they don’t require collateral to “secure” the money you’re borrowing. However, you’ll generally have to meet a lender’s minimum credit score requirements to get an unsecured loan, so if you don’t have a good credit score and can’t apply with a cosigner this may not be an option.

Secured Personal Loans

Conversely, secured personal loans are backed by collateral, such as your car or funds in a savings account. If you don’t have a good credit score, getting a secured personal loan could be easier than finding an unsecured option.

Debt Consolidation Loans

Personal loans used for debt consolidation combine multiple debts, such as balances from multiple high-interest credit cards. The benefits of a debt consolidation loan include that you’re streamlining your debt repayment into one monthly sum rather than several payments, and you could be able to get a lower interest rate.

Fixed-Rate vs. Variable-Rate Loans

Most personal loans have a fixed interest rate, meaning the interest you pay won’t change over time. This is helpful because you’ll know exactly how much you’ll pay every month, with no surprises.

While variable-rate personal loans are less common, you may come across this option. The downside is that your payment amount may change over time, and you have less predictability.

Cosigned or Joint Loans

Some lenders allow you to apply with a co-signer, which can improve your chances of approval, especially if your credit score isn’t high enough. A co-signer should be someone you know well and trust, both because you want them to have a good credit profile to help your approval odds and because they are taking on a risk by co-signing your application. If you aren’t able to repay the loan, the co-signer will be on the hook to make payments.

Joint loans are another option, but whereas co-signers don’t get any of the loan funds, a joint applicant does. So you’re essentially applying for the loans and sharing the money.

Typical Personal Loan Terms 

Personal loans can be for as little as a few hundred dollars or as much as $100,000, but most commonly they’re for amounts ranging between $1,000 and $50,000.

Personal loan terms vary as well, with bigger loans generally having the longest payback terms. Your loan term could be anywhere from 12 to 84 months, depending on your specific situation .

How Does Interest Work on a Personal Loan?

The interest you’ll pay on a personal loan depends on your credit score, as lenders view your credit as a representation of how likely you are to pay the loan back on time without any issues.

If you have a higher credit score, you’re considered less of a credit risk and will generally qualify for a lower interest rate, while lower credit scores represent more of a borrowing risk to lenders and therefore qualify for higher interest rates. Personal loan interest rates can range anywhere from 6% to 36% based on your creditworthiness.

Loan Fees

Beyond interest costs, many loans come with a variety of fees, including an origination fee when you first get the loan, late payment fees, and prepayment penalties. Not all lenders have these fees — make sure you review the loan agreement before signing so you know exactly what you’re getting into.

Here are some sample loan amounts with different term lengths and interest rates. You can see how this breaks down into different monthly payment amounts and how much you’ll pay in total to borrow money.

Are Personal Loans Bad? Pros and Cons 

To be fully informed, make sure you know the pros and cons of a personal loan before you get one. Personal loans aren’t 100% good or bad, but they have distinct advantages and disadvantages that determine who they are best for.

The pros of personal loans include:

• Fast access to cash 
• Fixed payments 
• No collateral needed (in most cases) 

The cons of personal loans include:

• High interest rates if you have bad credit 
• Risk of debt if not used carefully 
• May impact credit score if not repaid on time 

The biggest thing to keep in mind when borrowing money through a personal loan is that you should only borrow what you can afford to repay. Find a repayment term that works for you and ensure that monthly payment fits into your budget.

Is a Personal Loan Right for You? 

A personal loan might be a good fit for you if any of the following apply:

A personal loan might be a good fit if: 

• You need a lump sum of money quickly 
• You have a solid plan to repay it on time 
• You qualify for a lower interest rate than a credit card 
• You’re consolidating high-interest debt into one payment 

Conversely, a personal loan may not be right for you if:

• You’re unsure you can keep up with monthly payments 
• You have unstable income or poor credit 
• You’re tempted to borrow more than you need
• Other options like 0% APR credit cards or payment plans are available, and would cost less

What To Know About Personal Loans Before You Apply

Before you decide upon a personal loan, you should check your credit score to know if you’ll meet lenders’ requirements. Shop around with various lenders to get the best rates and terms, and make sure you understand all fees and the total amount of money you’re paying to borrow the funds.

And above all else, always only borrow the amount of money you need — it’s not worth the interest cost and potential for sustained debt to borrow more than you truly need or can afford.

Share This Article: