What Is a Personal Loan?

May 25, 2022


Personal loans are money that you can borrow for various purposes. A personal loan can be used to consolidate debt, pay off home renovations, or plan your dream wedding. Online lenders, credit unions, and banks can offer personal loans. You must repay the money borrowed over time, usually with interest. Personal loans may be subject to fees from some lenders.

How do personal loans work?

Personal loans are usually unsecured. This means they don’t have collateral backing them. Lenders will decide whether you get an unsecured loan based on your credit score, credit history, and debt-to-income ratio.

You may be eligible for a co-signed or secured loan if you aren’t qualified for an unsecured loan. A co-signed loan has a strong credit history and who will guarantee the loan. They are responsible for any missed payments. Assets like your car or home can back secured loans, and the lender may take possession of your property if you default.

This is a description of the various moving parts that make personal loans what it is:

  • Interest rates: Borrowers pay a fixed APR (or annual percentage rate) on top of their loan amount or principal. The interest rate on personal loans determines the interest that borrowers will pay over the loan’s life. The APR may vary depending on income, creditworthiness, and other factors.
  • Monthly payment: Personal loans have a fixed monthly fee. This payment is calculated by adding the principal and interest. If you pay your loan off over a more extended period, you can usually get a lower monthly installment.
  • Repayment timeline While repayment timelines for personal loans can vary, consumers often have the option to choose between one and seven-year repayment terms.
  • Origination fees: Personal loans may charge an origination fee in addition to the loan amount. Origination fees can vary widely, but it is common to see origination charges as high as 6 percent of the loan amount.

Other types of personal loans include fixed-rate loans. The rate and monthly payments remain the same or variable rate loans in which the rate and fees are subject to change.

How are rates determined

The APR of a personal loan determines the amount of interest you will pay over the term. Fixed rates remain constant throughout the loan’s life, while variable rates fluctuate. Personal loans can have a fixed rate. The APR is the interest rate for personal loans plus any fees or other charges incurred by the lender.

Variable rates are sometimes based on an index rate that is well-known, such as the prime interest rate. This is the rate at which banks lend to each other. Lenders can set a cap on a variable rate to ensure it doesn’t rise beyond a certain amount, even if the index rates increase. Personal loans typically have fixed APRs, which means your monthly payments are predictable.


Your credit score is the most critical factor in determining your APR. If you have a Personal loans

Although most personal loans operate in the same way, there are differences between loan products and lenders. These are the most important types of personal loans that you need to be aware of.

  • Unsecured personal loans: Personal loans are usually unsecured. You don’t need to provide collateral to be eligible. An unsecured personal loan will give you a lump sum. and You’ll then repay the loan in fixed monthly payments.
  • Secured personal loan: To qualify for fast personal loans, you must provide collateral. You may be eligible to use other assets instead of cash as collateral. If you are late on your payments, the lender might be able to seize these assets.
  • Credit-builder loan: Credit-builder Loans don’t give you a line of credit. The lender deposits the loans into a savings account. and You pay the balance over the term of the loan. Lenders report your payments to credit bureaus during this period to help you build credit history. You receive your full payment at the end of the loan.
  • Specialist lenders: Service-oriented businesses may offer personal loans to customers to help them pay for their products and services. For example, financing might be provided by a local home improvement store when you purchase a new appliance. Although these loans are often convenient, they may not offer the best rates or terms.

How do you choose the best personal loan?

The annual percentage rate of a personal loan is one of the best ways to evaluate it. The APR represents the total cost of borrowing, including any interest and fees.

An example of a personal loan of $10,000 at 15.5% APR with monthly payments of $487 and a 24-month repayment term of $387 would be $1,694, according to our personal loan calculator.

Lender rates range from 6% to 36% APR. Before applying, compare rates from different lenders. The loan with the lowest interest rate is usually the most affordable and the best option.


How personal loans affect credit scores

Personal loans can affect your credit score just like other forms of credit. Late payments will damage your credit score, but paying on time will build credit.

Your credit score will be affected if you apply for a loan. Pre-qualification with soft pulls is possible for most lenders. This won’t affect your credit score. After being preapproved, you can apply for credit. Which will trigger a hard pull. It typically subtracts less than five points from your score. It remains on your credit report for up to two years.

Common uses for personal loans

Personal loans allow you to use your loan proceeds in any way you like. Personal loans are flexible and highly adaptable; these are the most popular applications.


Debt consolidation

Consolidating debt with a loan is an unsecured personal loan that consumers can use to consolidate credit card debts or other debts. These loans are often offered at lower interest rates, which can benefit consumers who want to save money on interest and make lower monthly payments.

Expensive events

Personal loans are often used to finance expensive events such as a wedding or honeymoon. After the event, the borrower can repay the loan with fixed monthly payments and a fixed interest rate.

Investing in yourself

Personal loans can be used to finance educational expenses such as attending seminars or obtaining certification at work. Personal loans can be used to finance procedures that will improve self-images, such as cosmetic surgery or dental implants.

Home improvement projects

Consumers who are looking to remodel their homes use home equity loans and lines of credit (HELOCs). However, these loans will require that you put up your house as collateral. This is why many consumers opt for unsecured personal loans over home equity products. The consumer can borrow the funds they need to complete their project at affordable rates and terms. However, they do not have to risk their home.


Personal loans are also outstanding for emergencies such as unexpected medical bills, a roof replacement, or funeral expenses. Personal loans can be applied online. and Funds are available within a few days. This gives consumers financial security and peace of mind when there is an emergency.

When can you use personal loans?

Personal loans should be used to help you achieve your financial goals, not contribute to your debt problem.

A loan might be a good option if your home isn’t in great shape or you don’t want your home to act as collateral.

If the interest rate is lower, a personal loan could be a wise option to consolidate multiple debts. This type of loan allows you to pay down what you owe and then make monthly fixed payments towards the personal loan.

How do I get a personal loan?

These steps will help you get a personal loan.

  1. Credit repair. Higher credit scores will increase your chances of being approved for personal loans with the best rates. You can dispute errors in your credit reports and take steps to improve them before you apply.
  2. Reduce your debt as much as possible to be eligible for a loan that offers good terms. Paying off your debts and increasing your income can help if yours is higher than 45 percent.
  3. Compare loan rates from different lenders. Compare APRs, loan amounts and terms, and lender reputation. Prequalification is an option offered by some lenders that allows you to estimate your loan terms and credit without affecting your credit.
  4. Send documents to your lender. Once you have chosen a lender, you will need to apply for the loan in writing and provide financial information. These could include payslips or bank statements. Be prepared to explain how you will pay your bills if you don’t have work. Alternative income sources, such as unemployment benefits, are accepted by some lenders.
  5. Get the money. The lender will send the funds to you within a few days if your loan application has been received. The funds can then be used for the purpose you intended. You can avoid paying late fees and other damage to your credit score by setting up reminder payments.

Repaying a personal loan

Personal loans can be treated like any other type of debt. You need to understand how your monthly budget affects you and have a plan for paying off the loan.

Reexamining your budget could involve adding to your monthly payment and keeping an eye out for refinancing opportunities that offer lower rates.

Common errors when applying for a personal loan

These are the most common mistakes people make when getting a personal loan. Learn how to avoid them.

  • It would help if you didn’t borrow more than you could afford. If you default on your payments and take out a personal loan, it could cost you. Your credit score could be affected by the late fees and possible damage to your credit rating. Use a personal loan repayment calculator before you take on any debt. This will allow you to calculate your monthly payment and determine if it is within your monthly budget.
  • Avoid getting stuck with high fees and high-interest rates. Compare quotes from several lenders to find the best deal. Before applying for a loan, compare interest rates, fees, and the lender’s reputation.
  • Neglecting the loan costs. Even though you know the interest fees and other charges associated with your loan, you can forget about the actual price. Let’s take, for example, a $10,000 loan with a 10% APR and a 6% origination fee. This is a personal loan of 36 months. The origination fee will be $600, and the total interest will be $1,616. A loan calculator will help you understand the cost before applying for the loan.

Alternatives topersonal loans

Consider cheaper options than personal loans for discretionary expenses.

A credit card with 0% APR can be a great way to borrow money, especially if the balance is paid back during the initial period. You will not be charged interest for purchases during this period, lasting up to 21 months.

To qualify for a card at 0%, you must have good credit (above 690 FICO)

Another option is a personal line of credit. These are offered most often by banks and credit unions. They are a mix between a loan or credit card. A lender will approve your application just like a loan. However, unlike a credit card, you can only draw what you need and pay interest only for the amount you use.

Borrowers who don’t know how much they will need to borrow are best served by a line of credit. The best chances of getting approved for the lowest rates are for those with excellent or good credit.