How Do Personal Loans Work?

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If you need to borrow money, personal loans are a popular option. Nearly 19 million consumers had unsecured personal loans, with an average balance of $8,999 in the first quarter of 2021, according to TransUnion data.

Compared to credit cards, personal loans are often a better option because they tend to come with lower APRs and fixed payment amounts — but they can still affect your credit. Before you apply for a personal loan, here’s what you should know.

What’s a personal loan and how does it work?

Offered by banks, credit unions, or online lenders, a personal loan is a lump sum of money that you receive upfront. You pay it back via monthly payments with interest over an agreed-upon term or predetermined period of time. The amount you can borrow will depend on your lender and credit.

What can I use a personal loan for?

Unlike some other loans, personal loans are flexible — you can use them to cover virtually any expense. If you have a lot of high-interest credit card debt, for example, you can use a personal loan to consolidate it into one loan with a single monthly payment and a potentially lower interest rate.


You can also use a personal loan to help pay for medical bills, home improvement projects, moving costs, and unexpected financial emergencies. Some people even use personal loans for vacations, weddings, and other discretionary expenses. But you should carefully weigh the pros and cons of a personal loan for discretionary spending, since it’s a long-term debt that affects your credit and finances.

Where can I get a personal loan?

You can get a personal loan from a bank, credit union, or online lender. While banks and credit unions usually offer lower interest rates and more favorable terms, they may have stricter requirements, such as having good or excellent credit. Online lenders may be more lenient with their credit requirements, but in exchange for lending to someone with bad credit, they’ll likely offer higher rates and fees.

If you’re looking for a personal loan, Credible lets you compare rates from multiple lenders in minutes.

Types of personal loans

You can find personal loans for many different uses. Home improvement loans, medical loans, and debt consolidation loans are all examples of personal loans. Other types of personal loans include credit-builder loans and cosigner loans.

Unsecured personal loan

An unsecured personal loan isn’t backed by collateral or a physical asset you own, like a house, car, or boat. Since it requires a lender to take on more risk, an unsecured personal loan may come with a higher interest rate if your credit isn’t in great shape.

Secured personal loan

A secured personal loan is protected by collateral. This makes it less risky for a lender to offer you a loan, so even if you have little or no credit history, you may receive a lower interest rate than you would with an unsecured personal loan. But if you default on your payments, the lender can seize your collateral.

How do I get a personal loan?

If you’re interested in a personal loan, you’ll need to go through these steps to get one.

  • Decide how much you really need to borrow. Figure out the specific loan amount you need so that you don’t overborrow and steer yourself deeper into debt.

  • Check your credit reports. Go to to pull copies of your credit reports so you know where you stand and can dispute any errors.

  • Shop around and compare lenders. Research lenders that offer personal loans for your unique situation and compare their APRs, repayment terms, fees, and eligibility requirements.

  • Get prequalified. By prequalifying, you’ll know which types of loans you qualify for and find it easier to compare loan offers. Note that a prequalification differs from a pre-approval, which involves a more in-depth look at your credit and finances.

  • Go over loan details. Before you decide on a lender, review their APRs, terms, and fees. Remember that a higher APR can cost you thousands of extra dollars over the life of your loan.

  • Apply for the loan. Fill out an application online or in person and provide the required documents, like a government ID, pay stubs, bank statements, and utility bills.

  • Close the loan. Upon approval, carefully read the loan agreement and sign on the dotted line. Depending on the lender and loan, you may receive the funds within 24 hours, a few business days, or even the same day you apply.

Credible lets you compare personal loan rates from lenders in one place.

Things lenders consider when you apply for a loan

While they review your application, lenders will look at several factors to determine whether to lend you money.

  • Credit score/history: Your credit history shows how likely you are to repay what you borrow. The higher your credit score, the better.

  • Income: A regular income reassures lenders that you can pay back your loan.

  • DTI: Debt-to-income ratio, or DTI, refers to how much you owe each month versus how much you earn. A lower DTI is ideal because it shows you have a good handle on your debt.

  • Collateral: If you take out a secured loan, lenders will want to know what your collateral is and how much it’s worth. Collateral minimizes their risk of lending to you.

Repaying your personal loan

Once you take out a personal loan, you’ll need to follow a specific repayment schedule. You’ll typically pay back the money you borrowed via fixed monthly installments or payments over a set loan term. Since missed or late payments can hurt your credit, it’s important to make your monthly payments on time and in full.

Will applying for a personal loan hurt my credit?

Applying for a personal loan can affect your credit, depending on where you are in the process. When you get prequalified for a loan, a lender will run a soft credit check, which won’t affect your score. But once you select a lender and formally apply for a loan, the lender will run a hard inquiry, which can temporarily lower your score by a few points.

If you make your loan payments on time, you can improve your credit and open the door to lower rates and more favorable terms in the future. Missed or late payments, on the other hand, can take a serious toll on your credit.

To see what rates you may qualify for, compare personal loan rates using Credible.

Pros and cons of personal loans

Like every financial product, personal loans come with advantages and disadvantages. Here are some pros and cons to consider.

Pros of personal loans

  • Versatile — You can use personal loans to pay for virtually any expense, such as car repairs, medical bills, or a home improvement project.

  • Lower rates — Personal loans typically come with lower rates than you’d find with credit cards and other financing options.

  • Can repay over time — With a personal loan, you can take months or years to repay the money you borrow.

Cons of personal loans

  • Fees — Many personal loan lenders charge fees to lend you money, like origination fees, late fees, non-sufficient funds fees, and prepayment penalties.

  • Potential credit damage — A personal loan can hurt your credit if you make your payments late or default on the loan.

  • You’re taking on debt — When you take out a personal loan you incur debt, which can put a strain on your budget and limit what you can do with your money.

Other borrowing options to consider

If you don’t qualify for a personal loan or decide it’s not right for you, explore these alternative borrowing options.

  • 0% APR balance transfer credit card — If you have good credit, you may be eligible for a 0% APR balance transfer credit card. You’ll be able to move your debt to a no-interest credit card for a certain period of time without paying any interest. But it’s important to pay off the balance in full before the introductory period ends — otherwise you’ll start accruing interest at the card’s regular rate.

  • Start a side hustle — A side hustle may make sense if you’re not earning enough money at your full-time job. You may consider delivering groceries, tutoring, or making and selling crafts.

  • Ask friends or family — Your loved ones may be willing to lend you money, especially if you have an emergency expense. If you go this route, make sure the details of the loan are in writing so there’s no confusion and everyone is on the same page.

Anna Baluch is a personal finance freelance writer with years of experience writing for well-known media outlets in the business and personal finance space. Her work can be found on media outlets like The Balance, Freedom Debt Relief, LendingTree, Credit Karma, Nav, and RateGenius. She holds a bachelor’s degree in marketing from Northwood University and an MBA from Roosevelt University.

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