Key takeaways

  • A personal loan is money you can borrow in a lump sum with a fixed payment to finance large purchases, consolidate debt, invest in yourself or cover emergency expenses.
  • Interest rates, monthly payments and repayment terms vary based on creditworthiness, income and other factors.
  • You'll get the best loan terms if you improve your credit score and reduce your debt-to-income ratio before applying.

A personal loan is an installment loan with a fixed rate and monthly payment. Repayment terms at most personal loan lenders range between one and seven years. You receive all of the funds at once and can use them for nearly any purpose. Borrowers often use them to finance an asset, such as a vehicle or a boat, pay off debt or help cover the cost of a major expense, like a wedding or a home renovation.

You can get a personal loan from online lenders, banks and credit unions. Once you receive the cash, you make recurring monthly payments until the debt has been fully repaid over the term you choose.

People often choose personal loans because they feature lower fixed interest rates than credit cards and are easier to qualify for than home equity or mortgage loans. They’re also popular because they can be funded in as little as one business day, which is must faster than many other loan types.

How a personal loan works

A personal loan works a lot like an auto loan. You borrow the money from a bank or financial institution and pay it back in equal payments over a term that typically ranges between one and seven years. However, unlike a car loan, most personal loans are unsecured, so you don’t need any collateral, like a car, for approval.

Because personal loans aren’t secured, you’ll need to qualify primarily based on your credit scores and your debt-to-income ratio. Lenders measure this ratio by comparing how much you pay for other monthly credit accounts to your monthly income.

You can usually borrow between $1,000 to $50,000 or more, and interest rates currently range from about 6 percent to 36 percent. The lowest rates and highest loan amounts typically go to borrowers with excellent credit. Borrowers with credit scores as low as 500 may still be eligible for a bad credit personal loan. However, bad credit lenders may set shorter terms or approve lower loan amounts at much higher rates to cover their risk.

You’ll have to complete an application and wait for approval. The process can take anywhere from a few hours to several days. Once you’re approved, the lender will disburse money into your bank account. After you receive your funds, you begin to repay your loan. Lenders generally report account activity to the credit bureaus, so making on-time payments is crucial to building a positive credit history.

Features of personal loans usually include:

  • Fixed interest rates: Personal loan lenders charge fixed APRs, or annual percentage rates, based primarily on your creditworthiness and debt-to-income ratio.
  • Stable monthly payments: Personal loans come with a fixed principal and interest monthly payment for the life of the loan, calculated by adding up the principal and the interest. A fixed rate gives you the security of a predictable monthly payment, making it a popular choice for consolidating variable rate credit cards.
  • Repayment terms of up to seven years: Repayment timelines vary for personal loans, but consumers are often able to choose repayment terms between one and seven years. However, some lenders may offer terms of up to 12 years on larger personal loans for borrowers with excellent credit.
  • Origination fees: You may pay an initial origination fee of up to 10 percent for a personal loan. The fee is usually deducted from your funds when you finalize your application, reducing the amount of cash you pocket.

How personal loan rates are determined

Personal loans rates are more directly tied to short term rates like the prime rate. That makes them more likely to change when the Federal reserve raises or cuts the Fed funds rate. If you’ve already received funds from a personal loan don’t worry — your rate is fixed for the term of your loan.

The fixed rate nature of personal loans makes them a good tool for consolidating variable rate credit accounts, like credit cards. The APR you’re offered is based mostly on your credit score. If you have a good credit score, you may qualify for a lender’s lowest rates — the best rates typically go to people with credit scores above 700. Some of the additional factors that may impact the APR you’re offered include:

  • Income: Lenders like to see a steady and reliable income source like a salary or full-time hourly job to prove you can make your monthly payments.
  • Payment history: If you’ve managed your credit without late payments, lenders typically reward you with a lower interest rate.
  • Debt-to-income ratio: If a high percentage of your income is already used to pay debts, lenders may charge you a higher rate to cover the risk you might not be able to afford a new personal loan.
  • Loan term: You may be offered a lower APR for a shorter term, because lenders know your balance will be paid off faster. They may charge a higher rate for longer terms knowing the longer you have a loan, the more likely something could change in your finances that could make the payment unaffordable.

Common uses of personal loans

Personal loan proceeds can be used for almost any legal purpose. Some lenders may restrict you to only unsecured options, while others may allow you to secure a personal loan with an asset, like a car or boat. Overall, personal loan funds give you the cash to use for a variety of different purposes.

“If you’re tired of seeing your credit card balances barely budge when making minimum payments, a personal loan can help you reduce your balances much faster. Just make sure your budget is ready for a fixed monthly payment and you have consistent income to make the payments. Your credit scores may improve quickly after paying off revolving credit balances – as long as you don’t turn around and start using credit cards again.”

— Denny Ceizyk – Senior Loans Writer for Bankrate

Debt consolidation

Debt consolidation loans are the most popular type of personal loan for consumers who have racked up a pile of high-interest credit card debt or debt from other loans. Personal loan rates for debt consolidation are almost always lower than credit card rates, which could save you thousands of dollars in interest charges you’d pay sticking with credit card minimum payments.

Pay for emergency expenses

Fast funding turn times make personal loans a great option for financial emergencies, such as surprise medical bills, a leaky roof or even funeral expenses. You can apply online and receive funding within a few business days with very little paperwork.

Home improvement projects

If you don’t want to put your home up for collateral with home equity loans or home equity lines of credit (HELOCs), a personal loan for home improvement gives you money to complete repairs and renovations on your home.

Unsecured personal loans are also much easier to qualify for than home equity products. Funds can also be in your hands to get a project going in one business day, versus the weeks to months it can take to get funds from a home equity loan, HELOC or cash-out refinance.

Financing life’s big events

Major life milestones like a wedding or dream vacation often come with high price tags. If you don’t have the cash saved up or prefer not to deplete your bank accounts, a personal loan may help you fund a portion of your big event budget. A personal loan is also a good alternative to using credit cards, since you borrow money at a fixed rate with a definite payoff date based on the term you choose.

Keep in mind: When the honeymoon is over, the monthly payments will be a reminder of the money you spent. If you receive extra cash wedding gifts, consider paying the loan off faster so you can start your marriage with as little debt as possible.

Investing in yourself

A personal loan may be a good tool to finance self-improvement, such as pursuing a workplace certification or attending a career-boosting seminar. However, lenders may not allow you to use personal loan funds to pay for college tuition.

You can also get a personal loan to pay for procedures that improve your self-image, such as dental implants or cosmetic surgery. Make sure you have specific career or financial goals that justify the extra expense.

Refinancing an existing loan

If you took out a bad credit loan to consolidate credit card debt and your scores have improved, you can look into refinancing an existing loan. You could cut your interest rate – and payment in half – if you qualify for a good credit loan interest rate now.

Common mistakes when using a personal loan

Knowing the five common mistakes people make when taking out a personal loan can help you avoid them.

  1. Getting a longer loan term than necessary: The longer the loan term, the more interest you’ll have to pay during the life of your loan. Before taking on debt, use a personal loan repayment calculator to help budget.
  2. Not shopping around for the best offers: Gathering quotes from multiple lenders can help you spot the best deal and potentially save you interest. Compare interest rates, fees and lender reputation before applying for the loan.
  3. Not considering your credit score: Your credit score is a big factor in determining your eligibility for the loan as well as the interest rate. Some lenders may also charge higher origination fees for less creditworthy borrowers. Before applying, know what your score is so that you know what to expect in terms of costs.
  4. Overlooking fees and penalties: Be on the lookout for hidden fees and penalties by reading the lender’s terms and conditions page so you don’t end up with less cash than you need for your financial goals.
  5. Not reading the fine print: Before you sign and finalize the loan agreements, review the terms to make sure they’re what you agreed to.

“One other mistake to avoid is committing to a personal loan if your income is unstable. If you earn the bulk of your income from variable income like commissions or tips, a fixed payment may be tough to handle if you have a low earnings month. Also, don’t choose a short term unless you’re sure you can make the payments. For example, if you depend on a spouse’s income to cover half your expenses, a short-term personal loan payment could become a burden if your spouse is laid off.”

— Denny Ceizyk – Senior Loans Writer for Bankrate

Next steps

If you need to borrow money and prefer the stability of a fixed repayment schedule and fixed monthly payment, a personal loan could be exactly what you need. To get the best loan rates and terms, work on improving your credit and paying down existing debt in order to get the most competitive loan rates and terms.

It’s also important to shop around and compare personal loan rates with multiple lenders in the personal loan space, including companies that offer online loans.

Frequently asked questions

  • Personal loans are great for short- to medium-term borrowing at rates that are typically lower than credit card rates. They’re also a good option if you don’t want a secured loan like a car or home loan. They’re a good option if you have good credit and a specific financial goal in mind.
  • No. Personal loans require proof you have the credit profile and income to repay them. Although they’re easier to qualify for than home equity loans or other secured loans, you still need to show the lender you have the means to pay the loan back.
  • Personal loans are better than credit cards if you want a set monthly payment and need all of your funds at once. They also feature fixed rates, so you don’t have to worry about your payment changing like they do with most variable rate credit cards.

    Credit cards may be better if you need the flexibility to draw money as needed, pay it off and re-use it. Credit cards may also offer rewards or cash-back options that personal loans don’t.

    Ultimately, the best credit product for you will depend on your money habits and what you need the funds for.