Personal loans are a popular choice for people who need money to cover a range of expenses. It’s easy to qualify for a personal loan when you have good or excellent credit, but some lenders cater to borrowers with poor credit as well.
While personal loans can be very flexible, here’s how a general personal loan works along with what to consider when deciding which personal loan is right for you.
- How does a personal loan work?
- What can you use one for?
- How do you qualify?
- How to get a personal loan
- What to consider
- Alternatives
How does a personal loan work?
Personal loans work similarly to any other loan. You borrow money from a lender and agree to pay it back with interest over a set time frame. Personal loans, however, are typically unsecured loans that don’t require any collateral, such as a car or home.
Instead, the lender will use your credit score and other factors to see if you qualify for the loan. Banks, credit unions, and online lenders all offer personal loans. Loan amounts and repayment periods can vary depending on the lender’s terms. Repayment terms typically range from one to seven years, but some lenders offer repayment terms up to 12 years for very large loan amounts. Many lenders allow you to borrow up to $50,000, and some offer $100,000 personal loans or more.
Personal loan interest rates are typically fixed, meaning the rate won’t fluctuate over the life of your loan, and your monthly payment will be the same until the loan is paid off.
The average personal loan interest rate was around 11.48% for a two-year personal loan, according to the Federal Reserve’s most recent data. But your rate could be much higher, such as 30%, if you have bad credit. On the other hand, it could be much lower, such as 6%, if you have excellent credit.
The best personal loans often provide quick funding once you’re approved. Some lenders provide funds as soon as the same day. Lenders will usually deposit the funds directly into your bank account or, with a debt consolidation loan, you can often request that your creditors be paid directly.
What can you use a personal loan for?
Personal loans can have several uses, and lenders don’t place many limits on what you can use the loan for. However, you usually cannot use a personal loan for secondary education expenses, such as tuition. Here are some common uses for personal loans (it’s always important to check with your lender, as this isn’t an exhaustive list):
- Debt repayment: Personal loans can help you consolidate debt, such as multiple credit card balances. With a personal loan, you can pay off your high-interest debts and repay the loan with one monthly payment, often at a lower interest rate.
- Medical bills: If you’re unable to establish a satisfactory payment plan for your medical bills, a personal loan can help you pay them off and avoid having accounts go to collections.
- Major life events: Are you planning a wedding or trip? Personal loans can help you fund major life events and budget for regular repayments afterward.
- Financing a vehicle: A secured auto loan usually offers a lower interest and may make sense for most people. But a personal loan could be an option for a car that won’t qualify for traditional financing, such as an older or classic car.
- Unexpected expenses: Personal loans can also come in handy when you’re faced with an unexpected emergency expense and need money fast. Though, it’s important to only borrow what you need to ensure you can repay the loan on time and in full.
How to qualify for a personal loan
Lenders look at a few different criteria to determine whether to approve a personal loan. Fortunately, you can still get a personal loan with bad credit, as your credit score is not the only factor that lenders consider.
- Credit score: Lenders consider your credit score to determine their risk in lending you money. Usually, the higher your credit score, the lower your interest rate.
- Income: You’ll typically need to show proof of your income with pay stubs or bank statements to confirm you have steady work and enough income to repay a personal loan.
- Debt-to-income ratio: Your debt-to-income ratio (DTI) is the total amount of your minimum monthly debt payments divided by your pretax monthly income. Lenders usually prefer a debt-to-income ratio of less than 35%.
How to get a personal loan
If you’re interested in applying for a personal loan, here’s how to get started:
- Check your credit: Start by checking your credit to see where you stand. If your credit score is under 650, know that you may not receive the best loan terms, and you may have a harder time qualifying. Work on improving your credit score before applying for a loan, if possible.
- Compare lenders and prequalify: Next, compare lenders by looking for ones that fit your personal criteria. If you have a low credit score, for example, find lenders that offer personal loans for bad credit. Many lenders let you prequalify for a loan online in just a few minutes, which can be a great way to compare rates and terms between lenders. Prequalification doesn’t hurt your credit.
- Apply and submit supporting documents: Once you’ve found a loan you like, submit an application with the required documentation, like recent paycheck stubs or bank statements.
- Review loan terms and sign the loan agreement: After your application is processed, you’ll receive the final loan terms if approved. Carefully review the terms and make sure you agree with the loan amount, monthly payment, payment dates, fees, and other important information.
What to consider when choosing a personal loan
There are several things to consider when choosing a personal loan, including:
- Eligibility requirements: Lenders have specific credit score and income requirements. Check to make sure you meet these requirements before applying to streamline the process.
- Loan amounts: Each lender sets minimum and maximum borrowing amounts, which can vary. Make sure you’re able to borrow the amount you need from a particular lender before applying for a loan.
- Repayment periods: Some lenders offer longer repayment periods than others. Make sure any lender you consider offers a repayment term that works with your needs and budget.
- APR: The annual percentage rate (APR) is the best way to compare how much lenders will charge you to borrow money. The APR includes both the interest rate and fees, like an origination fee. This is important because the interest rate alone could be lower with one lender relative to another, but if that lender charges a hefty origination fee, the cost of the loan could actually be much higher.
- Funding timeline: If you need money quickly, the time to fund a personal loan is an important factor. Some lenders provide funds the same day your application is approved, while others might take up to a week or more to disburse loan funds.
- Fees: Some lenders charge an origination fee to process your loan application, which could be as high as 12% of your loan amount. This is why it’s crucial to consider the APR when comparing lenders instead of just the interest rate.
| Important: If you’re charged an origination fee, that amount is typically deducted from the loan proceeds. This means that the loan funds you receive would be less than what you actually applied for and were approved for. Be sure to factor this in when deciding how much money to borrow. |
Personal loan alternatives
A personal loan is not the best option for everyone. Consider these alternatives to be sure it’s the best option for you:
- Home equity loan: A home equity loan lets you borrow against the equity in your home and pay a fixed interest rate that may be lower than what you’re currently paying. Home equity loans have upfront fees, and you must use your home as collateral, which can make this borrowing option more of a risk if you default on the loan.
- Personal line of credit: A personal line of credit is a loan that you can access from time to time to draw funds as needed. It’s similar to a credit card — generally unsecured, with a credit limit, and available from banks and credit unions. You usually need a checking or savings account with the institution to be eligible.
- 0% APR credit card: If you have good credit, a 0% APR credit card can be a good alternative to a personal loan. Since the 0% APR period may only last several months before adjusting to the card’s regular interest rate, it’s crucial to pay off the entire amount within that time.