What Is a Personal Loan?
A personal loan is a form of credit that borrowers can use for any purpose, such as consolidating debt, refinancing and making big purchases. Personal loans usually are not backed by collateral, so they are often for lower amounts and have higher APRs than other types of installment loans. Personal loans also have relatively short repayment terms, with most requiring full payment in 12 to 60 equal monthly installments.
How Do Personal Loans Work?
Personal loans let you borrow a sum of money from a lender and then pay it back in monthly installments over a set term – usually one to seven years. Those monthly payments include equal portions of the original loan amount, plus interest and fees. One common type of fee is an origination fee to open the loan, though this is not always incorporated into the monthly payments. Sometimes, it’s charged upfront, and some lenders do not charge it at all.
How Personal Loans Work
- Application. You will need to provide personal information (such as your address and SSN), financial information (such as your income and employment status). The lender will evaluate and hopefully approve you.
- Disbursement of funds. The issuer of the loan will deposit the money into your bank account as a lump sum. You can do whatever you wish with the money, unless the terms of the loan say otherwise.
- Interest. From the day you take out the loan, the amount will begin accruing interest at a rate set by the issuer. So no matter how long it takes you to pay the loan back, you’ll always owe more than you originally took out.
- Monthly payments. The lender will give you a required amount to pay each month. You can pay more if you’d like, but make sure there’s no penalty for paying the loan off earlier than the terms of the contract stipulate. Some lenders may charge a fee, but that’s very rare.
- Credit building. The lender will report to the credit bureaus whether you’ve paid on time each month. Once you’ve paid off the entire balance, including interest and fees, the lender will report your loan as paid in full. Abiding by the terms of your loan can help increase your credit score.
What Can a Personal Loan Be Used For?
A personal loan can be used for nearly anything you want. Some common reasons to apply for a personal loan include home projects, rent payments, medical expenses, debt consolidation or starting a small business. You could also use your funds for things that are less essential, like vacations or wedding expenses. More than one-third of people think travel is a debt-worthy expense, according to a WalletHub survey.
Another big thing that a personal loan can be used for is credit improvement. No matter what the overall purpose of your personal loan is, if you pay on time each month, the lender will send positive information to the credit bureaus. In time, this will help raise your credit score. But if your main reason for wanting a loan is to improve your credit score, you might want to consider a credit-builder loan, which is designed specifically for that purpose.
Who Can Get a Personal Loan?
Whether or not you’re able to get approved for a personal loan will depend on your credit history, income and existing debt, along with other factors that may vary by lender. Most unsecured personal loans will require a credit score of at least 600, and those that don’t have an origination fee usually require a score of at least 660. But there are also secured personal loans, which require collateral, that are available even to people with bad credit.
In general, anyone is eligible for a personal loan if they are at least 18 years old and a U.S. resident (some lenders accept people with immigration visas as well). A minor can’t be held accountable for a binding contract (such as a personal loan agreement) in most states, so lenders generally do not offer personal loans to minors.
Some personal loans are available only to people with a bank account, however, and some lenders require a Social Security number. On the other hand, several lenders will let you apply with an Individual Taxpayer Identification Number or your passport instead of an SSN.
So to summarize, if you’re an adult living in the U.S. and you have a bank account, you should have no problem applying for a personal loan. Just make sure to apply for loans you have a good chance of qualifying for. You can use WalletHub’s free pre-qualification tool to find loans with high approval odds.
Types of Personal Loans
- Unsecured Personal Loans: Approval is based on your creditworthiness – that is, a combination of your credit score, income, expenses, recent inquiries and more.
- Secured Personal Loans: These loans require that you put down something of value as collateral (such as an auto title, property or stocks). The lender can keep the collateral if you default. Because there’s less risk for the lender, secured loans are open to people with subpar credit scores.
- Fixed-rate Loans: The interest rate stays the same for the life of the loan.
- Variable-rate Loans: The APR is connected to an index rate, which can rise or fall as the market changes.
Personal Loans vs. Other Borrowing Options
|Borrowing Option||How it works||Main advantage||Main disadvantage|
|Personal loan||Receive a lump sum and pay it off over time||Potential for low interest rates||Credit score of 600-660+ usually needed|
|Credit card||Draw from a credit line indefinitely until the account closes||Borrow whenever you need to and carry a balance between months||Potential for a low credit limit|
|Home equity loan||Get a lump sum secured by the equity in your home||Potential for very high loan amounts||Could lose your home if you default|
|Home equity line of credit (HELOC)||Draw from a credit line secured by the equity in your home||Potential to borrow very high amounts||Could lose your home if you default|
|Payday loan||Borrow against your next paycheck||None (not worth it)||Extremely high fees (often equivalent to 400% APR)|
|Auto title loan||Borrow money for 15 - 30 days secured by your car||None (not worth it)||Extremely high interest (as much as 25% of what you borrow)|
|Pawnshop loan||Borrow part of an item’s value and repay it by a certain date to reclaim the item||Fast cash – not as risky if you don’t care about the item||Very high interest;
Shop can sell your items if you don’t repay
|Loan from family/friends||Form an agreement with the individual||Could get low interest and lenient payback terms||Could ruin your relationship|
The first major alternative to a personal loan is a credit card. With a personal loan, you receive a lump sum of money and pay it back over time. But a credit card allows you to borrow up to a certain amount of money any time you want. But unless you have a very high income and spotless credit, personal loans will usually offer the potential to borrow more.
Another borrowing option is a home equity loan. As the name suggests, it allows you to borrow against the “equity” of your home, which is the market value minus the balance on the mortgage. Depending on your house’s value and how much you’ve paid off, you could borrow much bigger amounts than with a personal loan. But be careful, because if you default the lender could foreclose on your house. There are also home equity lines of credit, which let you borrow up to a certain amount whenever you want to for a given time period.
Those are the most reliable alternatives to a personal loan. There are other options, like payday loans, auto title loans and pawn shop loans, but they are too expensive to consider except as a last resort. You can also potentially borrow from friends and family, but that comes with its own issues, like causing relationship problems if you can’t repay.