A personal loan is financing extended by an online or traditional lender that you can use for a range of personal purposes. If you’re facing travel expenses, home or auto repair costs or other unexpected expenses, a personal loan can help you access the money you need—sometimes in as little as 24 hours. We’ll walk you through how personal loans work, how to apply for one, and common alternatives so you can be sure you’re making the right decision.
How Do Personal Loans Work
Personal loans are issued by a range of institutions, including online and peer-to-peer lenders, traditional banks and credit unions. Loan proceeds are dispersed as a lump sum, and interest begins to accrue on the entire loan amount as soon as the loan is issued. Interest rates and repayment terms vary based on the lender and the borrower’s needs and qualifications. Origination fees also vary, but typically range from 1% to 8% of the loan amount.
Personal loan interest rates depend on several factors, including the borrower’s credit score, income and debt-to-income ratio. On average, rates range from just 3% for the most qualified borrowers up to 36% for applicants who pose more risk to lenders. Personal loan interest rates are usually fixed over the life of the loan but can be variable.
In general, a personal loan term—or the time a borrower has to pay off a loan—varies from two to seven years. However, as with interest rates, these terms vary based on the lender, loan amount and the borrower’s creditworthiness. A borrower’s loan offer will include details about the amortization period, monthly payment amount and date by which the loan must be paid off. Use our personal loan calculator to get an idea of what your monthly payment would be.
Many lenders charge origination fees to cover the cost of reviewing the borrower’s application, verifying their income and otherwise processing the loan. This fee is typically between 1% and 8% of the total loan amount, but varies by lender. In some cases, these fees are subtracted from the total loan amount, while other lenders tack the fee on to the loan principal.
Notably, not all lenders charge origination fees on personal loans—in fact, many advertise fee-free loans—so consider this when shopping for the most favorable terms.
Who a Personal Loan Is Right For
A personal loan is an excellent financing option for those who need to access a lump sum of cash quickly and without limitations on its use. While personal loans can offer fast and flexible financing, they can be expensive—with origination fees and interest charged on the entire loan amount. For that reason, a line of credit may be a suitable alternative for borrowers who need money over an extended period of time rather than all at once.
Applicants should have a credit score of at least 610 to 640 to qualify for a personal loan. Even so, prospective borrowers with lower credit scores can also qualify for personal loans, though the interest rates will likely be higher and the terms less favorable.
Types of Personal Loans
Personal loans can either be secured, meaning the loan is guaranteed by an asset like the borrower’s house—or unsecured, meaning collateral is not required. Interest rates are typically lower for secured loans because this form of financing poses less risk to lenders; for the same reason, these loans usually have more lenient borrowing requirements than unsecured loans. That said, whether a secured or unsecured loan is best depends on the borrower.
Beyond collateral, personal loans also can have either fixed or adjustable rates. Fixed-rate personal loans are those where the interest rate and monthly payment stay the same for the entire life of the loan. This is the most common form of personal loan. In contrast, the interest rates of adjustable-rate loans change over time—usually starting out low and increasing after a certain period of time.
If you think a personal loan may be a good fit for your financial needs, familiarize yourself with the different types of personal loans before applying.
How to Apply For a Personal Loan
Personal loans are available from online lenders as well as traditional banks and credit unions. Prospective borrowers can typically apply for a personal loan online, but some lenders require an in-person meeting. While the application process varies by lender, follow these general steps when applying for a personal loan:
- Check your credit score. Before you apply for a personal loan, check your credit score for free through your credit card issuer or another website that offers free scores. This will help you anticipate the likelihood of getting approved and can give you a better idea of what kind of interest rate to expect. When applying for a personal loan, aim for a score of at least 610; however, a score over 720 will yield the lowest interest rates.
- If necessary, take steps to improve your credit score. Checking your credit score will also reveal whether you need to improve your creditworthiness before applying for a loan. You then can take steps to lower your credit usage rate or make other improvements based on your credit report.
- Determine how much you need to borrow. Once you have a comprehensive understanding of your credit score, calculate how much money you want to borrow. Remember, though, that personal loans are issued as a lump sum, and you’ll have to pay interest on the entire loan amount—so don’t borrow more than you need.
- Shop around for the best terms and interest rates. Many lenders offer an online prequalification process that lets you estimate your likely interest rate with just a soft credit inquiry. This means you can shop around for the most favorable loan terms without damaging your credit score. You’ll often be able to prequalify in just a few minutes, but some lenders take longer.
- Submit a formal application and await a lending decision. After identifying the most competitive personal loan option available, submit a formal application. At this point, you’ll need to consent to a hard credit check, which can impact your credit score, and the lender will identify the exact terms of your loan. Depending on the lender, this process can take anywhere from a few hours to a few days.
What Can You Use Personal Loans For?
Generally speaking, you can use personal loans for any personal purpose unless it’s specifically prohibited by a lender under the terms of the loan. However, there are many common reasons to get a personal loan. Here’s a list of things personal loans are frequently used for:
- Home improvements and repairs
- Medical bills
- Wedding expenses
- Vacation and travel
- Funeral costs
- Debt consolidation
- Unexpected expenses
That said, lenders prohibit the use of personal loans to fund illegal activities. Some lenders also restrict the use of personal loans to cover education-related expenses or to refinance other debt. Depending on the lender, you may also be prohibited from using the proceeds of a personal loan to cover business-related expenses.
Personal Loan Alternatives
Personal loans are a flexible financing solution for borrowers who qualify. However, depending on your needs and creditworthiness, a personal loan may not be the best option—or an option at all. Luckily, there are several popular personal loan alternatives to consider:
- Savings. If you can cover your expenses with savings—instead of taking out a loan—you’ll avoid fees and interest. Keep in mind, however, that taking money out of a qualified retirement account early generally comes with an early withdrawal penalty. So this option should be avoided when possible.
- Credit card. When comparing personal loans vs. credit cards, credit cards typically have higher interest rates, but credit cards may be easier to qualify for if you have poor credit. However, if you have a strong credit score, you may qualify for a 0% introductory offer, which can save you money on interest payments.
- A personal line of credit. Unlike a personal loan, which is disbursed as a lump sum, a personal line of credit lets borrowers access funds up to a certain limit on an as-needed basis. With this type of financing, the borrower only pays interest on what they actually access. This makes a line of credit an excellent option for projects or events where expenses will be spread over several months or years.
- Home equity loan or line of credit. Home equity lines of credit (HELOCs) and home equity loans are financing options that are backed by a borrower’s equity in their home. If you’re considering a loan that’s secured by your home, consider the differences between HELOCs and home equity loans before signing on the dotted line.