The Basics of Personal Loans

Couple speaking with loan officer
© Ariel Skelley / Creative RF / Getty

Personal loans are one of many types of loans you can borrow from a bank. These loans are typically general purpose loans that you can use at your discretion for things like consolidating debt or paying for an unexpected expense or small home improvement project. Personal loans are often more difficult to get and have strict qualification requirements. If you're thinking about borrowing a personal loan, here are some things you know.

Personal loans are unsecured.

That means the loan doesn't require you to use an asset as collateral. If you default on a personal loan, the lender can't automatically take a piece of your property as payment for the loan. This is one of the reasons personal loans are more difficult to get. The lender doesn't have any asset to seize if you can't make loan payments anymore. Even though the lender can't automatically take your house or car, it can take other collection actions. This includes reporting late payments to the credit bureaus, hiring a collection agency, and filing a lawsuit against you.

Personal loans have a fixed amount.

The amount of personal loans ranges anywhere from $1,000 to $50,000 and depends on the lender, your income, and your credit rating. The better your credit score and higher your income, the more money you can borrow. Some banks have a cap on the amount of personal loan you can borrow.

For example, you may be able to borrow only a maximum of $10,000 personal loan.

Unlike credit cards, personal loans are a one- time loan. You can't borrow from the loan over and over the way you can with a revolving credit card balance. Payments toward the loan reduce the balance, but do not open up available credit that you can borrow again.

Once you pay off the loan, the account is closed. If you need to borrow again, you'll have to reapply.

Personal loans usually have fixed interest rates.

The interest rate is locked and doesn't change for the life of the loan. Like the loan amount, interest rates on personal loans are based on credit rating. Generally, the better your credit score, the lower your interest rate. Lower interest rates are ideal because it means you pay a lower cost for borrowing the loan. Some personal loans come with a variable interest rate that changes periodically. The drawback of a variable interest rate is that your payments can fluctuate as your rate changes making it harder to budget for your loan payments

Personal loans a fixed repayment period.

You have a set period of time to repay your personal loan. Loan periods are stated in months, e.g. 12, 24, 36, 48, and 60. Longer repayment periods lower your monthly loan repayment, but they also mean you pay more in interest than if you had a shorter repayment period.  Your interest rate may also be tied to your repayment period. For example, you may have a lower interest rate with shorter repayment periods. Longer repayment periods also mean you'll be paying on the loan for a longer period of time.

Having an open loan could affect your ability to get approved for other credit cards and loans. Note that some loans have a pre-payment penalty which charges a fee for paying off your loan early.

Personal loans affect your credit score.

Most lenders report your loan account details to the credit bureaus. . Everything from applying for a loan (which means a new inquiry on your credit report) to how timely you make payments will affect your credit. The key to maintaining a good credit score is making your loan payments on time each month.

Beware of scams.

Watch out for scams, particularly if you're shopping for a lender who'll approve you with a bad credit history. Avoid any lender that guarantees approval without checking your credit history or who asks you to send money (especially via wire transfer or prepaid card) to secure the loan.

Applying for a Personal Loan

It may be easier to get a personal loan from a bank you already have an account with. The bank will probably want to know what you're going to use the money for and may even have a better loan for your needs. As with any other loan, it's important to choose personal loans wisely and only borrow what you can afford to repay.