What Is a Personal Loan? Definition, Types and More
A personal loan is an installment loan that provides funds borrowers can use for any purpose, unlike an auto loan or a mortgage, which are reserved solely for the purchase of certain property that is then used as collateral for the loan. 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. There’s just more risk for the lender. However, there are some secured personal loans available for people who want to put up collateral. Personal loans also have relatively short repayment terms, with most requiring full payment in 12 to 60 equal monthly installments.
Personal loans are available from banks, credit unions and online lenders. Some of the biggest, most popular personal loan companies are American Express, Avant, LendingClub and SoFi. Personal loans are not new, either, despite becoming increasingly popular in recent years, fueled by the rise of FinTech startups.
Below, you can learn more about what personal loans are, how they work and when it makes sense to apply for one.
What Can a Personal Loan Be Used For?
A personal loan can be used for anything you want. Some common reasons to apply for a personal loan include home projects, rent payments, medical expenses and debt consolidation. Other good reasons to get a personal loan include starting a small business or taking a loan specifically to build credit and diversify the types of credit shown on your credit report.
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. It’s better to save for such purchases than borrow, but the possibilities are nevertheless endless with personal loans.
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. There are secured personal loans, which require collateral, that are available even to people with bad credit.
That said, anyone is eligible for a personal loan if they are at least 18 years old. A minor can’t be held accountable for a binding contract (such as a personal loan) in most states, so lenders generally do not offer personal loans to minors. Some personal loans are also available only to people with a bank account. If you’re an adult with a bank account, you can apply for any personal loan you’d like.
If you’re not a U.S. resident, you may or may not be able to get a personal loan, depending on the lender. You might be able to apply with an Individual Taxpayer Identification Number or your Visa instead of a Social Security number, depending on the issuer.
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.
Both unsecured loans and secured loans can have either a fixed or variable interest rate. Fixed rates are most common.
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)|
|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.
How to Get a Personal Loan
- Compare options. Use WalletHub’s tool to check credit requirements, APRs, estimated monthly payments, loan lengths and more. Consider visiting your local banks and credit unions, too.
- Check for pre-qualification. Most lenders will allow you to see if you pre-qualify for a personal loan and to estimate your rates. Being pre-qualified doesn’t guarantee approval, but it means your odds are great.
- Apply. You will have to provide personal info (name, address, SSN), financial info (income, employment status, housing payments) and more. Make sure you fill out everything honestly and accurately.
- Wait for your funds. It generally takes at least 1-7 business days to get the money after personal loan approval.
Now that you know what a personal loan is, you’re in a better position to consider applying for one. The most important part of the process is comparison shopping, and you can easily compare personal loans right here on WalletHub. You can filter for your credit level, the loan amount, your location and the number of months to pay back what you borrow. Once you see your offers, you can compare their rates, payments and fees.
You can also see if the lender will pre-qualify you. If you’re pre-qualified, you can apply with much more confidence that you’ll be approved (though it’s never certain). If you are not pre-qualified for a particular personal loan, consider offers from other lenders instead so you don’t waste a hard inquiry on your credit report.
Image: one photo / Shutterstock
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