- Unlike credit cards, personal loans offer fixed interest rates and monthly payments.
- Personal loans can be used for debt consolidation or major home remodeling projects.
- Most personal loans are unsecured, meaning you don't have to put down collateral to borrow money.
There are several reasonable ways to get cash when you need it. You may be able to get a small loan from family or friends, and you can always apply for a credit card. But there's another option to consider that comes with certain advantages: a personal loan. While personal loans may have gotten a bad rap in some circles, the best personal loans can offer a predictable way to borrow money, ideally with low interest rates and minimal fees.
What is a personal loan?
Definition and types of personal loans
A personal loan is money you borrow from a bank, credit union, or online lender that you repay with interest over a set period of time. Personal loans are installment loans, like mortgages and car loans. In other words, all the money is issued up front, and you repay the loan with fixed payments over a predetermined loan period.
Unlike many other types of installment loans, unsecured personal loans are standard, like credit card debt. That means you don't need to provide any collateral. Average personal loan interest rates tend to be higher than the rates on secured loans but lower than credit card interest rates.
The role of personal loans in financial planning
Personal loans let you borrow a predetermined amount of money with a fixed interest rate and set repayment period. They also come with fixed monthly payments that you agree to ahead of time, making budgeting for your loan a whole lot easier. This is also the main difference between personal loans and lines of credit in general.
Personal loans with low interest rates are available if you have good credit.
Here are the most important details you need to know about unsecured personal loans:
- You borrow a fixed amount of money.
- You get a fixed interest rate, a fixed monthly payment, and a fixed repayment period.
- Most personal loans are unsecured, but it is possible to get a secured loan.
How do personal loans work?
Using a personal loan
While you can take out a personal loan for any reason (or no reason at all), these loans are popular for consumers who need to borrow money for a specific reason. Let's say you want to remodel your kitchen but don't have the $30,000 the project requires or enough home equity to qualify for a home equity loan or home equity line of credit (HELOC). In that case, a personal loan could offer the money you need for your project, provided your credit is good enough to qualify.
Personal loans are also popular to consolidate debt, and it's easy to see why. Imagine you're a consumer with high-interest credit card debt that's sucking your budget dry every month. A personal loan could help you consolidate that debt at a lower interest rate while securing a predictable monthly payment and a set payoff date that doesn't change.
Here's an example of how this could work: Say you have $10,000 in credit card debt with the average credit card APR of 17%. If you paid $250 each month, you would pay a total of $14,862 for 60 months (including principal and interest) before your balance was paid off. If you were able to consolidate that $10,000 balance at 5% APR and make the same $250 monthly payment, however, you could become debt-free in 44 months for a total cost of $10,962.
Other reasons consumers get personal loans are nearly limitless, but can include:
- Borrowing money for a car
- Paying for higher education
- Paying for important home repairs
- Covering surprise bills and expenses
Understanding personal loan requirements
To get a personal loan from a bank, you'll generally need to provide a credit score and credit history, proof of income, debt-to-income ratio, and collateral for a secured loan, says Gabe Krajicek, CEO of Kasasa, a fintech company that provides financial products and marketing services to community banks and credit unions.
"Bank of America, like some other megabanks, does not offer personal loans," Krajicek says. "Others, like Citibank and Wells Fargo, may offer personal loans only to account holders and have minimum credit and income requirements to qualify."
Banks face more regulations than online lenders, so they have the strictest lending standards, says Priyanka Prakash, lending and credit expert at Fundera. Online lenders are generally more flexible.
You can use a personal loan marketplace like LendingTree or Credible to request rates from multiple lenders at the same time.
Credit score requirements
Minimum credit scores
Your credit score determines your loan eligibility, so finding your score is an important requirement for a personal loan.
You can usually find your score for no cost on your credit card statement or online account. You can also pay for it from a credit reporting agency. If your credit score is in the low 600s or less, look into how to get a loan with bad credit, which may involve opening a secured loan or going through a credit union.
How credit scores affect loan terms and interest rates
Your credit score is a three-digit number that measures your likelihood to repay a debt. It's based on the information contained in your credit report, which monitors all of your credit-related activity.
You can find your credit report for free on annualcreditreport.com from any of the three major credit bureaus. While this report won't give you your credit score, it will show you information about your credit and payment history, which lenders use to decide whether to give you a personal loan. Reviewing your credit report can help you know what you need to improve.
How to get a personal loan
Preparing to apply for a personal loan
When shopping for a personal loan, you are better off comparing several lenders in terms of their rates, fees, and fine print. You'll obviously want to choose a loan with the lowest interest rate you can qualify for, but fees matter, too.
You can prequalify for a personal loan with many lenders before you submit an application. This allows you to see the rates and terms they're likely to offer you before they do a hard credit inquiry, which will likely result in a slight dip in your credit score for a short time.
While comparing loan interest rates, you can calculate the loan's real interest rate to factor inflation in. If you have a negative real interest rate, inflation exceeds the loan's nominal interest rate, which means you're coming out ahead even while holding debt.
Some personal loan companies charge an origination fee that can range from 1% to 8% of your loan amount, along with application fees and other fees. However, the highly competitive nature of the personal loans business means that many personal loans come free of fees for consumers who qualify.
It's important to take into account fees associated with a personal loan to make sure it doesn't make the total cost of your debt higher in the end. Your best bet is shopping around with several lenders to find an option that suits your budget and needs.
As you compare personal loan companies, you'll want to look for:
- A lender that offers competitive interest rates
- No fees or minimal fees
- A monthly payment and loan term you can afford
Also, consider how quickly you need money and look at quick personal loan options if you need them right away.
Necessary documentation and eligibility criteria
While some companies will lend you money with a credit score in the low 600s, you may need to put down collateral to qualify. At the very least, you'll pay a much higher interest rate to get a loan with bad credit.
Most lenders list a minimum credit score to qualify for a loan on their website, with many drawing the line in the mid-600s. With a credit score below what is considered "very good credit," or 740, however, you will likely pay a higher interest rate.
In addition to checking your credit score, most personal loan requirements include proof of employment and your ability to repay the debt. Lenders will also check your debt-to-income ratio to make sure you haven't borrowed more than you can feasibly pay back.
If your credit isn't great, you can take steps to improve your credit score before you apply to get a loan with the best possible rates and terms. Like other financial products, compare offers from many lenders before making a decision.
Collateral requirements
There are two types of personal loans: secured and unsecured. Many of the best personal loans are unsecured.
Unsecured loans aren't supported by collateral, like a house, car, or other assets. Lenders evaluate whether to grant you the loan based on your financial history and credit score.
If you don't qualify for an unsecured loan, lenders also offer secured options that can be backed by assets, bank accounts you have, or other things you own. Mortgages, home equity loans, and auto loans are considered secured loans, since you're putting up collateral.
Remember that if you take out a secured loan using your home, your car, or something else as collateral, you run the risk of losing those things should you become unable to pay your loans.
"Because unsecured loans don't require collateral, they are viewed as riskier and may have a higher interest rate to offset this risk," Krajicek says.
Some lenders that offer unsecured loans, including banks and credit unions, will also offer secured loans.
Coborrowers and cosigners
If you have bad credit or limited credit history, adding a coborrower or cosigner to your loan application can improve your chances of being approved for a personal loan and securing better terms.
Coborrowers share equal responsibility for repaying the loan and typically have access to the loan funds, while cosigners act as a guarantor and are only responsible for repayment if the primary borrower defaults. Both are valuable options for improving loan approval chances, securing lower interest rates, and accessing better loan terms.
Watch out for personal loan scams
Personal loan scams can be especially damaging, targeting individuals who need quick cash or have limited borrowing options. Scammers often promise guaranteed approval, low interest rates, or no credit checks, only to disappear after collecting upfront fees or stealing personal and financial information.
To protect yourself, research any lender thoroughly before applying. Check reviews, verify that the lender is registered with the appropriate financial authorities, and ensure all loan terms are clear and transparent. Be cautious of unsolicited loan offers, especially those that pressure you into making quick decisions. Legitimate lenders will never demand upfront payments or make guarantees without reviewing your financial history.
If an offer seems too good to be true, it likely is. Take your time to compare lenders, read the fine print, and avoid loans that come with vague terms or high-pressure sales tactics.
The best way to get a personal loan
Taking out a new loan is not something that should be rushed. Take your time researching lenders and asking questions to make an informed decision. Here is a breakdown of the steps you can take to get a personal loan.
- Decide how much you need to borrow and calculate what kind of payments can fit into your budget.
- Check your credit. Get familiar with your credit score and clear up any mistakes on your credit report prior to beginning the loan application process.
- Look for lenders that let you prequalify. This allows you to compare rates without hurting your credit score.
- Compare lenders. Make sure you understand what each lender is offering. Consider the lender's reputation, repayment terms, interest rates, fees, restrictions, potential discounts, and how fast you'll receive your funds.
- Submit a loan application. Once you've picked the lender you'd like to work with, you'll have to submit a formal loan application. Most lenders let you complete the application online.
- Wait for approval and accept the loan. Once the lender approves your loan, they will send you a loan agreement. Many lenders will approve your loan the same day you apply. Don't forget to read the fine print before you sign the agreement to make sure you fully understand what to expect.
- Add the loan payments to your budget. Avoid falling behind on your loan payments by including them in your budget.
Tips for meeting loan requirements
Understand your credit score
If you are looking to take out a personal loan to consolidate credit card debt, or pay debt down faster, it can help in more ways than you may realize. Making payments in a reliable, timely manner will have a positive impact on your credit score as the lender reports these payments to the three major credit bureaus.
Paying down debt can also help improve your credit utilization ratio, which is the percentage of available credit you are using. Experts advise keeping this ratio at 30% or below.
Taking out a personal loan can actually help boost your credit score because your credit mix — which refers to the types of different credit accounts you have — determines 10% of your overall credit score.
Shoot for preapproval
Although it's not a solid guarantee, preapproval is when a lender extends an unofficial offer on a personal loan, pending full approval.
In this instance, preapproval will tell the borrower what loan amount, terms, and repayment schedule they will likely qualify for in advance. Also, a preapproval acknowledges that the borrower has met the bank loan requirements.
You won't impact your credit score if you check your loan rates for preapproval, because most companies only produce a soft credit inquiry when pulling your credit report. That won't be visible to third parties or affect your credit score.
The process usually includes an application and a credit history evaluation. Remember that while it's a worthwhile step to take, there's no guarantee that the bank will extend the exact same terms when it comes time to issue a personal loan.
Check if your bank offers personal loans
If you're wondering how to get a personal loan from a bank, the first step is to check whether your bank offers this type of financing. To get a personal loan from a bank, you'll generally need to be an existing customer with good credit.
If your bank doesn't offer loans — or even if it does — you may want to get quotes from the best online lenders and credit unions. These options can be an alternative to bank loans, or a basis for comparison.
After you've checked rates offered by online lenders and credit unions, see if your bank will offer you a better deal. For instance, US Bank personal loans are more attractive for existing customers because they can get better terms and qualify with a lower credit score. You can generally fill out a form to see if you prequalify for a loan based without triggering a hard inquiry on your credit.
Know the terms
Personal loans are installment loans, which is when you borrow a fixed amount of money and pay it back with interest in monthly installments over the life of the loan.
The terms of personal loans can range from 12 to 96 months. When you complete the loan terms, that loan is considered closed. If more money is needed, you must apply for a new loan.
Tabitha Mazzara, director of operations for MBANC, a consumer-direct mortgage lender, says there are a few questions you should ask yourself before signing on the dotted line.
"You should know how much you need before going into it," says Mazzara. "What are the terms? When will I have to pay it back? What's the interest? Can I afford the payment? What are the fees?"
Common loan terminology
Understanding key loan terms can help you make an informed decision when borrowing money. Here are a few important ones to know:
- Annual Percentage Rate (APR): This represents the total cost of borrowing, including interest and fees, expressed as a yearly percentage. A lower APR generally means a more affordable loan.
- Origination fee: A one-time charge that lenders may deduct from your loan amount to cover processing costs. Origination fees typically range from 1% to 8% of the loan amount.
- Fixed vs. variable interest rate: A fixed rate remains the same for the duration of the loan, providing predictable payments. A variable rate can change based on market conditions, potentially increasing your monthly payment.
- Prepayment penalty: Some lenders charge a fee if you pay off your loan early. Check your loan agreement to see if this applies.
- Debt-to-income ratio (DTI): Lenders use this percentage to measure your total monthly debt payments relative to your income. A lower DTI increases your chances of loan approval.
Estimating monthly personal loan payments
Estimating your monthly personal loan payments is essential for considering how to budget and additional financial planning. Your payment amount depends on factors like the loan amount, interest rate, and loan term. Using a personal loan calculator or an online tool can help you determine what you'll owe each month before committing to a loan.
Longer loan terms generally result in lower monthly payments but increase the total interest paid over time, while shorter terms lead to higher payments but lower overall costs. Before taking out a loan, compare offers from different lenders and ensure the monthly payments fit within your budget.
Create a repayment plan
Before you get your loan, make sure you have a plan to pay it back. How much will you owe per month? Do you plan to pay the minimum required, or to make extra payments and pay it back more quickly?
Consider setting up automatic payments from your checking account once your paycheck clears, or calendar reminders to make sure you never miss a due date.
There are many steps you need to take to get a bank loan, and it is worth taking extra time to compare all your offers before settling on a particular company.
Check for personalized loan offers
Quickly get your personal loan rates without impacting your credit score.
FAQs about how personal loans work
How does interest work on a personal loan?
Personal loan interest rates are determined by your income, loan amount, your debt-to-income ratio, and repayment terms. Secured loans typically have lower interest rates than unsecured loans because they are backed by collateral.
Can I pay off my personal loan early?
Many lenders allow you to pay off a personal loan early, but some may charge a prepayment penalty. Always check the lender's policy before making extra payments.
What do I need to qualify for a personal loan?
Qualification criteria for a personal loan include a minimum credit score, stable income, debt-to-income ratio, and sometimes collateral for secured loans.
How quickly can I get a personal loan?
Depending on the lender, you can get approved and funded for a personal loan in as little as one day to a week of application.
What's the difference between a fixed and variable interest rate?
Fixed rates remain the same throughout your personal loan's term, offering predictability. Variable rates can change, affecting monthly payments and total interest paid.
