A personal loan is an unsecured type of installment credit. You borrow money without putting up collateral, which you then pay back with fixed monthly payments over a set time. You qualify for personal loans based on your credit score and can use the funds for a range of purposes.
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Personal loan rates and terms
Amount: $1,000 – $50,000
Term: 12 to 60 months
Cost: Loan origination fee (1-5% of the amount borrowed)
Interest Rate: 10-28%
Personal loan APR can vary widely based on your credit score. If your credit score is bad, the rates can be as high as the rates on credit cards.
| Credit Score | Interest Rate Ranges |
|---|---|
| Excellent (720 – 850) | 10.3% – 12.5% |
| Good (680 – 719) | 13.5% – 15.5% |
| Average (640 – 679) | 17.8% – 19.9% |
| Poor (300 – 639) | 28.5% – 32.0% |
Fees to avoid
Almost any personal loan will have an origination fee, which covers the underwriting and administrative costs of the loan.
It’s also fairly standard that you will face a late fee if you do not make the payment by the due date.
However, some personal loans have additional fees listed in the terms of the agreement. Early repayment or prepayment penalty fees get applied when you make an extra payment or larger payment than required.
You essentially get popped with extra fees for trying to eliminate the debt earlier than outlined in your contract.
These fees should be avoided, when possible. You always want to have the ability to repay debt quickly if your budget allows for it. You don’t want to face extra fees for doing that.
How do personal loans work?
Step 1: Before you apply
Prior to applying for a personal loan, you need to check your finances and define some goals. These loans can be a great option, but they can also create financial challenges when used in the wrong circumstances.
Ask yourself these questions
- What’s the purpose of the loan and how much money do you need to cover it?
- Is the need immediate or could you avoid taking out the loan by saving up to pay in cash?
- Will you be able to comfortably afford the loan payments?
- Do you have time to improve your credit to get a lower rate before you apply?
If you don’t know where your credit stands, it may be a good idea to check your reports before you apply. You can also check your score using a credit monitoring tool. That way, you’ll know what interest rate you can expect to pay.
It can also be helpful to use a loan calculator to assess the monthly payments you’ll need to cover. You can use the calculator to see how choosing a shorter or longer term will affect the payments.
Gather up the documentation you need
Anytime you apply for a loan, you will need documents proving who you are and how much income you have.
Making sure you have all the documentation you need will ensure that the application and underwriting process goes as quickly and smoothly as possible.
Step 2: Shopping for the right loan
The next step is to find the best loan and lender to fit your needs. You want to compare rates and terms from several different lenders before you apply for a loan. This means you need to get quotes from several different lenders.
It’s a good idea to start with your bank or credit union. Online loan comparison tools make it convenient to see loan offers from a range of lenders all at once.
They’ll ask for some basic personal information, your estimated credit score and what you need the funds for.
Based on this information you will receive a loan offer from each lender. Lenders will generally tell you the following in an offer:
- how much you can borrow
- an estimated interest rate or range of rates you can expect to pay
- ways to reduce the interest rate, such as signing up for AutoPay
- how quickly you can get approved
Tip: Be careful when shopping for loans that you do not start the application process with a lender. You only want to apply for one loan once you find one that seems to fit your needs. Applying for multiple loans at once can damage your credit score. Make sure to ask for quotes only.
Compare loan offers in minutes!
Step 3: Application and loan underwriting
When you find the right lender based on the offer you receive, you can apply for the loan. Now the lender will ask for more detailed information about you and the loan you want to take out.
Your application will be assigned to a loan underwriter. They will review all the information you provide to make sure you qualify for the loan. The underwriting process includes:
- A credit check that you must authorize. This check will appear on your credit report.
- Checking your debt-to-income ratio with the new loan payments included. This ensures you can afford the payments
If you qualify, the underwriter works with you to set the term of the loan, which determines your monthly payments. Once you have everything set, the underwriter will draft the loan agreement.
You must sign and return the agreement, at which point your loan becomes official.
Step 4: Disbursement and loan repayment
Once your loan agreement is signed and returned, the lender will disburse the funds.
In most cases, you receive the money from the loan with a lump-sum direct deposit into your bank account. Using direct deposit is beneficial, because it allows you to receive the money faster, usually within 1-2 business days.
Your loan payments will begin the month after you receive the funds. Make sure you know the due date of the new bill so you can pay the first installment promptly. Setting up AutoPay where the funds are debited from your bank account can be helpful.
You will make fixed monthly payments for the term of the loan that repay the principal (the amount you borrowed) plus interest. Making extra payments or larger payments can help minimize interest charges and the total cost of borrowing.
What can you finance with a loan?
The funds from a personal loan can be used to help achieve almost any financial need or goal.
- Debt consolidation
- Home improvement
- Major repairs (home, HVAC, auto)
- Medical expenses
- Pregnancy and adoption costs
- Veterinary expenses
- Large purchases or expenses
- Starting or funding a business venture
- Investment seed money
You can use the funds for a combination of purposes. For example, let’s say you have a medical procedure that you need, but your insurance doesn’t cover it. You can get a personal loan to cover those expenses based on the estimate that you receive. Then you can use additional funds to pay off a few credit card balances.
Types of Personal Loans
- Debt Consolidation Loan
- Personal Line of Credit
- Point Of Sale Financing
- Cash Advance
- Payday Loan
- Co-sign Loan
Rules for borrowing
Find the right loan to fit your needs.
If you have trouble getting approved…
There are two basic reasons you get rejected for a personal loan:
- You don’t have a strong enough credit score
- You don’t have enough income
Overcoming credit score challenges
The most common reason people get rejected for a loan is that they don’t have the credit necessary to qualify. You either have bad credit or you have a “thin credit history” – meaning you basically have no credit yet.
If this the reason that you don’t qualify, don’t run out and start looking for loans that don’t require a credit check. These loans will have extremely high interest rates and come with a high risk of creating financial hardship.
Instead, you need to take some time to build your credit. The exact method you use will depend on your score.
If you have bad credit…
Start by checking the credit utilization ratio on your credit card accounts. This is the ratio that measures the balance on the account versus the total available credit limit. Anything higher than 30% will hurt your score.
So, if you have credit cards sitting at 50% utilization or higher, that could be a big factor in why your score is low. Focus on paying off your existing credit card debt.
Making all your payments on time will also help you build a positive credit history. If you’ve missed payments in the past, that’s also hurting your score. Positive actions now will help offset those missteps.
If you have no credit…
If the lender simply says your credit file is simply too thin to qualify, there are a few things you can consider.
- Credit builder loans are small personal loans that you take out specifically for the purpose of building credit. You make installment payments for 12-24 months and then receive the money you paid in back. It’s a great way to build your score while forcing yourself to save at the same time.
- Secured credit cards are also designed to help people build credit. You put down a small cash deposit to open the credit line. Since that deposit secures the limit you get, you can qualify regardless of your credit score.
Overcoming income challenges
If you’re rejected for a loan based on your income, it’s usually for one of two reasons.
The first is obvious – you don’t make enough money to qualify. In this case, you may need to get a second job or seriously consider if you can afford to borrow. If you have an immediate need for cash, do whatever possible to avoid high-risk borrowing options such as payday loans. Consider if you can sell items for cash or borrow money from a friend or family member.
The second reason is a little more nuanced – you have income, but you already have too much debt for what you make. In this case, you may be able to solve your problem by paying off debt so you can afford to borrow again.
If you’re consolidating debt, consider alternatives
A debt consolidation loan is not the only solution for getting out of debt more efficiently. If you’re in a situation where you have a bad credit score or too much debt already to borrow, you have options. Instead of taking on new debt to get out of debt you already have, you may need professional help.
Your first step should be to get credit counseling. A certified credit counselor can help you evaluate your debts and budget to determine the best way for you to get out of debt. They may recommend:
Connect with a certified credit counselor to review your options.
Article last modified on May 1, 2023. Published by Debt.com, LLC
contributors
Howard DvorkinAuthor
CPA - Debt.com Chairman & Personal Finance Expert
Steve RhodeAuthor
The Get Out Of Debt Guy
