The Basics of Personal Loans

They're not like credit cards, and qualifying for them can be more difficult

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

Personal loans are general purpose loans. You can usually use the funds at your discretion, although some lenders will restrict what you do with the money. They're often more difficult to get compared to credit cards. They come with sometimes strict qualification requirements and their own unique rules. 

Why Take Out a Personal Loan?

Many consumers take out personal loans and use the proceeds to pay off their credit cards.

This can offer a couple of benefits. First, you'll have only one—not several—monthly payments, and you might find that your loan's interest rate is lower than the average interest rate of all your cards. Of course, if your credit is good enough to qualify for a card with a zero percent balance transfer rate, you'd better off using that card. 

Student loans also tend to come with some high interest rates, so you might find that paying them off with a personal loan saves you some money. But beware: personal loans don't come with the same tax advantages as federally recognized student loans. Check with a tax professional first to make sure you don't get dinged at tax time.

You might want to pay for a significant purchase or event, such as new appliances or a wedding, but you just don't have sufficient savings on hand to pull it off. Compare the terms you're offered against the terms and interest rates you'd incur if you put the charges on a credit card.

Personal Loans Are Unsecured

You're not required to place an asset as collateral when you take out a personal loan, so the lender can't automatically take a piece of your property as payment if you default. This is one of the reasons personal loans are more difficult to get.

But personal loan lenders can take other collection actions even if they can't automatically take your house, car, or other assets.

These include reporting late payments to credit bureaus, hiring a collection agency, or filing a lawsuit against you.

A Personal Loan Is for a Fixed Amount

The amount of personal loans ranges anywhere from $1,000 to $50,000, depending on your lender, your income, your other debt, and your credit score. The better your credit score and the higher your income, the more money you can borrow.

Most banks place caps on the amount you can borrow. For example, you might only be able to borrow a maximum of $10,000 even if you're a very qualified borrower with an excellent income, if the lender's policy is to offer no more than that. 

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 they don't open up more available credit that you can borrow again. The account is closed when you pay off the loan. You'd have to reapply if you wanted to borrow again.

Personal Loans Usually Have Fixed Interest Rates

The interest rate on a personal loan is usually locked. It doesn't change for the life of the loan. But 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.

Interest rates on loans are based on your credit score. Generally, the better your credit score, the lower your interest rate. Lower interest rates are obviously ideal because this translates to paying less in exchange for borrowing the loan. 

Other Common Fees

Virtually every lender will charge late fees if your payments fall behind, and many charge origination fees as well in exchange for setting up the loan. Origination fees can run from about 1 to 6 percent of the amount you're borrowing. These fees can also depend on your credit score. 

Personal Loans Have Fixed Repayment Periods

You'll have a set period of time to repay your personal loan. Loan periods are usually stated in months: 12, 24, 36, 48, or 60. Longer repayment periods lower your monthly loan repayment by dividing the principal amount borrowed by more months, but you'll also pay more in interest than if you had a shorter repayment period because interest is added on per payment.

Your interest rate can be tied to your repayment period as well. You might get a lower interest rate if you finance the loan over a shorter period.

Having an open loan can affect your ability to get approved for other credit cards and loans, so you might not be able to borrow more for an additional two years if you take the loan out for five years rather than three. And it's not always possible to pay the loan off early if you find yourself in this predicament. Some loans have a prepayment penalty for paying off early.

Personal Loans Affect Your Credit Score

Most lenders report your loan account details to the credit bureaus, which then include that information on your credit report. Everything from applying for a loan (which means a new inquiry on your credit report) to how timely you make payments affects your credit.

You can often minimize the new inquiries if you're shopping around for personal loan rates by applying within a limited period of time, or trying to get preapproved. Preapprovals don't always show up as hard inquiries that everyone can see on your credit report and they don't affect your score. 

The key to maintaining a good credit score is making your loan payments on time each month and consistently paying down your loan balance.

Applying for a Personal Loan

It might be easier to get a personal loan from a bank where you already have a relationship. The bank will probably want to know what you're going to use the money for and might even have a better loan for your needs.

As with any other loan, choose your personal loans wisely and borrow only what you can afford to repay. Take time to calculate what your monthly payments will be so that you're sure you can incorporate those payments into your budget. 

Compare rates before settling on a lender. You might want to try to borrow less or give your credit score some time to improve if you're being offered money at high interest rates. 

The Current Marketplace

A multitude of lenders offer personal loans, and terms and conditions can vary significantly between them. Banks and credit unions tend to offer good rates, but some online lenders offer even better terms, particularly to those with very good credit. Online lenders can also be more forgiving of poor credit. 

As of 2018, some of the more popular and reputable lenders include:

  • Avant: Borrow up to $35,000 and apply online so you'll know within minutes if you've been approved. Your loan can be funded within 24 hours. Rates range from 9.95 percent to 35.99 percent, depending on the terms and your credit history. 
  • LendingClub: Personal loans with flexible terms are available from $1,000 to $40,000, and you can apply online. This is a peer-to-peer lender, not a bank. 
  • LendingPoint approves those with fair to good credit and considers merit-based qualifications, such as employment history and the amount of debt you're currently carrying. 
  • LightStream: You'll need good credit to qualify with this lender, but interest rates are reasonable and LightStream does not charge an origination fee. It doesn't allow you to borrow to pay off student loans, however. 
  • Upgrade: This company offers loans of up to $50,000. These loans also typically fund within 24 hours.

Beware of Scams!

Watch out for loan 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 first checking your credit or that asks you to send money—especially via wire transfer or prepaid card—to secure the loan. You can always check with the Better Business Bureau or the Consumer Financial Protection Bureau if you're unsure.