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Banking Basics

What Is a Personal Loan?

Personal loans can help you consolidate debt, cover a major expense or just get ahead financially. Here's how to decide if one is right for you.

Rebecca Lake • February 8, 2022

In This Article

  1. What is a Personal Loan?
  2. Different Types of Personal Loans
  3. How Do Personal Loans Work?
  4. What Can You Use Personal Loans For?
  5. Personal Loan Pros and Cons
  6. FAQs
  7. Final Thoughts

When you need money–whether it’s to consolidate debts, pay for an emergency, or get caught up on everyday bills–a personal loan is one option you might consider. 

Personal loans are just what they sound like–loans made to an individual person. You might choose a personal loan over a credit card or another type of loan when you need to borrow, but how do they work exactly?

This primer explains how to get a personal loan and what to expect. 

What is a Personal Loan?

A personal loan is a loan made by a lender directly to a person. The loan is paid out as a lump sum of money. The borrower can then use that money to meet a variety of financial needs. 

Personal loans can be offered by banks, credit unions, online lenders and non-bank fintech companies. A personal loan isn’t the same as a personal line of credit or a credit card. Those are both types of revolving credit, meaning that your available credit can fluctuate as you make purchases and pay them down.

With a personal loan, you get one lump sum of money that has to be repaid to the lender, typically with interest. Assuming you pay on schedule, your loan balance only goes down over time until it eventually winds up at $0.

Different Types of Personal Loans

There are two broad categories of personal loans: secured and unsecured. 

A secured personal loan requires collateral or security. If you don’t pay back the loan, the lender keeps your collateral. Credit builder loans are one of the best examples of secured personal loans.

With a credit builder loan, you might have to open a savings account or certificate of deposit (CD) account with the lender. They approve you for a loan but instead of handing over the money, they put it into the savings or CD account where it earns interest. 

You pay back the loan, according to the loan term set by the lender. Once the loan is paid off, the lender gives you the money in the savings or CD account, along with the interest earned. 

So what is an unsecured loan? Unsecured personal loans don’t require collateral. It’s generally easier to get an unsecured loan when you have a good credit score. 

How Do Personal Loans Work?

Personal loans work by giving you access to a lump of money, which you then repay over time. The lender charges interest for the loan and you might also pay fees as well. For example, some personal loan lenders charge an origination fee, which is a fee for making the loan. Lenders can also charge late fees if you don’t pay on time or prepayment penalties if you pay the loan off early. 

Every lender is different when it comes to the details of the loans they offer. That’s why it’s important to keep these things in mind when comparing loan options:

  • Minimum and maximum loan amounts
  • Interest rate ranges and whether those rates are fixed or variable
  • Loan fees
  • Repayment terms
  • Any added benefits, such as interest rate discounts for autopay enrollment

Short-term personal loans might have terms of 12 months or less while longer-term loans might allow five or six years to pay them off. Depending on the lender, you might be able to borrow as much as $100,000 with a personal loan. In terms of interest, it’s possible to find loans with rates starting around 5% or as high as 30%. 

But what do you need to get a personal loan? Some of the things lenders consider include:

  • Credit scores and credit history
  • Income and employment status
  • Other debts and your debt-to-income ratio
  • Collateral, if you’re applying for a secured personal loan

As a basic rule of thumb, the better your credit score is, the easier it is to get approved for a personal loan. A higher credit score can also help you lock in a lower interest rate. Getting a personal loan with bad credit isn’t impossible. But you might pay more for it in interest if it means a higher interest rate. 

What Can You Use Personal Loans For?

Personal loans can be used to meet a wide variety of financial needs. Some of the things you might use a personal loan for include:

So, is there anything you can’t use a personal loan for? 

The answer is it depends. Many lenders, for example, don’t allow you to use personal loans to pay for higher education expenses. Some don’t allow you to use them for business expenses either. And if you’re trying to buy a home, you typically can’t use personal loans to pay for your down payment or closing costs. Lenders expect those payments to be made in cash from savings or the sale of assets. 

Personal Loan Pros and Cons

Should you get a personal loan? The answer can depend on what you need the money for and how much it might cost you to borrow. Here are some key pros and cons to consider with this borrowing option. 

Personal Loan Pros

  • You may be able to borrow more than you would with a credit card or line of credit
  • Personal loans can offer low fixed rates to eligible borrowers
  • Fixed rates means payments are predictable so it’s easier to budget
  • Personal loans are flexible, in terms of what you can use them for
  • No collateral is needed if you qualify for an unsecured personal loan

Personal Loan Cons

  • Interest rates could be higher than other borrowing options for people with lower credit scores
  • Fees and penalties can increase the total cost of borrowing
  • Budgeting could be difficult if monthly payments are higher
  • Failing to repay a secured personal loan could result in the loss of your collateral

Something else to consider is that personal loans could add to your debt if you’re using them to consolidate credit cards. You could end up owing more total if you charge new purchases to your cards after using a personal loan to pay them off. 

FAQs

Can I get a personal loan with bad credit?

It’s possible to get a personal loan with bad credit or limited credit history. It’s important to keep in mind, however, that you might pay more for the loan or be limited to a lower loan amount, based on your credit scores.

How to calculate interest on a loan?

The simplest way to calculate interest on a personal loan is to use an online calculator. You can plug in the amount you plan to borrow, the interest rate and the repayment term to quickly see how much interest you’ll pay total for the loan. 

What do you need to get a personal loan?

If you’re applying for a personal loan online, you’ll need to share some basic information with the lender. This includes your name, date of birth, Social Security number, email address, phone number and mailing address. A good credit score can help to increase your odds of getting approved. You’ll also need collateral if you’re applying for a secured personal loan. 

What is the interest rate on a personal loan?

The interest rate on a personal loan represents the amount of interest you pay to the lender for the convenience of borrowing money. The interest rate you pay for a personal loan can depend on your credit score and other financial factors, as well as the loan amount and the repayment terms. 

Final Thoughts

Personal loans can help you to fill money gaps when you need to pay off debt or cover some other expense. But it’s important to do your research first. Making sure you understand how much you’re borrowing, what you’ll pay in interest and how much your monthly payments will work out to can help you decide if a personal loan fits into your financial plan. 

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