How Do Personal Loans Work?
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- Personal loans typically have a fixed interest rate and term length, allowing borrowers to make a clear, predictable repayment plan
- Personal loan funds can be used for a variety of reasons, from consolidating high-interest debt to paying for a wedding or a car repair
- Some personal loans offer same-day approval and funding to qualified borrowers
Personal loans offer borrowers the chance to use funds for nearly anything they need. These types of loans can be used for a variety of purposes, from paying for home improvement projects or medical bills to buying an engagement ring or consolidating high-interest debt.
You can get a personal loan from a bank, credit union or online lender. While you’ll usually pay less interest on a personal loan than a credit card, your APR will depend on a few different factors, including your credit score and income.
What is a personal loan?
A personal loan is a fixed amount of money borrowed at a fixed rate and repaid over a fixed amount of time.
Personal loans can either be secured or unsecured. Here are some key differences between the two types:
- Unsecured personal loans: Personal loans are often unsecured, meaning they don’t require collateral. Because of this, lenders heavily weigh factors like your credit, income and outstanding debt when evaluating you as a potential borrower. Getting this type of personal loan with bad credit can be difficult, or outright expensive.
- Secured personal loans: These require you to offer up collateral to back your personal loan. If you fail to make payments, the lender can seize your collateral. Since the collateral reduces the lender’s risk, you’ll typically find secured personal loans can be easier to qualify for and offer more favorable terms.
Personal loans by another name
As you’re searching for personal loans, you may find lenders that advertise them under different names, including:
Regardless of what they’re called, these loans fall under the umbrella of personal loans and usually work the same way. However, some lenders will offer different personal loan terms based on the intended purpose for the loan, or only offer personal loans for certain purposes.
How interest rates on personal loans work
The way interest rates on personal loans work is based on a few factors, such as your credit score and income. The interest rate refers to the percentage of the balance that you’ll be charged each month, and the higher your credit score is, the lower your interest rate can be.
Personal loans are installment loans. That means you’ll repay a fixed amount at a fixed interest rate for the duration of the loan term. Generally, the more the lender thinks of you as a risky borrower, the higher the interest rate will be. You can use LendingTree’s personal loan payment calculator to figure out the total amount you’ll pay on your personal loan.
To get a more accurate sense of what a personal loan will cost you, you’ll want to take a look at the annual percentage rate (APR). Like interest rates, APRs are expressed as a percentage, but they also take into account fees, interest and other factors to give you a better sense of the total cost of the personal loan.
Range of personal loan APRs
The best average APRs on personal loans range from 9.80% for borrowers with credit scores of 760 and 24.20% for people with scores between 640-679 as of February 2020.
Take a look at the example below to see how your APR affects your monthly payment and overall loan cost.
What determines your borrowing amount
Many borrowers wonder how big of a loan they can get. The amount you can qualify for depends on the lender and your eligibility for credit. Personal loans typically start at $1,000 and go up to $35,000 or higher. If you need to borrow amounts outside that range, you’ll want to do some homework on different lenders before you submit an application.
Getting a personal loan: What to expect from the application process
While taking out a personal loan is relatively simple, it does require a bit of legwork to get prequalified for a decent APR. Here’s what to expect from the application process:
- Review your credit score: Your three-digit FICO credit score plays a big role in your ability to borrow money and score a favorable interest rate. Check your credit score to know where you stand.
- Shop around and get prequalified: Interest rates can range widely from lender to lender, so you’ll want to shop around to explore your options. Most lenders allow you to see loan offers with a soft credit check through prequalification. This can help you see the types of loan terms you may qualify for. However, prequalification is not a guarantee that you’ll be approved when you submit a formal application.
- Compare loan offers: After prequalifying with a few lenders, compare your loan terms as well as each lender’s fees. Once you’ve found a lender you’d like to apply with, it’s time to move forward.
- Gather supporting documents: Lenders may require you to submit additional documents when you apply for the loan. Start gathering materials like proof of income (such as copies of paycheck stubs), proof of debt (like mortgage statements) and bank account statements now so that you’re ready for the application.
- Accept an offer: You’ll now submit a formal application with your lender of choice. Online personal loan applications usually require you to agree to a hard credit check. Follow the instructions on the application, and submit any documents the lender asks for.
- Wait for your money: Lenders usually make decisions pretty quickly after receiving your complete application and pulling your credit report. You might even get an answer within hours. The amount of time it takes to receive the money will depend on the lender. Some offer same-day funding with an electronic deposit to your bank account.
If you need money right away, you might consider adding a cosigner to your personal loan application to potentially help you qualify and get a lower interest rate.
Is a personal loan right for you?
Personal loans can be useful during specific instances, such as covering an emergency expense, consolidating higher interest debts or paying for something essential, like a repair on a vehicle you use to get to and from work. Just because a personal loan can be used for just about anything doesn’t mean it should be treated like extra money, though. Interest adds up, and the monthly payments can be stressful, depending on your situation.
Weigh all available options before taking out a personal loan. You might consider tapping your rainy-day fund for interest-free funds or exploring credit cards with a promotional APR offer before taking out a personal loan. If you’ve decided a personal loan is the right move, make sure to shop around for your best rates and understand all the terms and conditions before signing on the dotted line.