Personal Loans: What You Need to Know Before Borrowing

They're generally accessible to borrowers with good credit and don't require collateral like other loan types.

However, understanding the complete picture—including potential drawbacks like higher interest rates compared to secured loans and strict credit requirements—is essential before committing to a personal loan.

What is a Personal Loan?

A personal loan is an installment loan from banks, credit unions, or online lenders that you repay in fixed monthly payments over a set term. These loans can fund debt consolidation, home improvements, medical bills, or major purchases.

Most lenders offer personal loans ranging from $1,000 to $50,000, though some extend up to $100,000. Personal loans come in two main types:

• Unsecured loans: The most common option with no collateral required. Your assets remain safe even if you default, but you'll need stronger credit to qualify.
• Secured loans: Require collateral like a car or savings account that the lender can seize if you don't repay. These are easier to qualify for since they reduce the lender's risk.

How Do Personal Loans Work?

Personal loans typically feature fixed interest rates that never change, with set monthly payments over a defined term (usually 2-5 years, though some lenders offer shorter or longer periods).

The personal loan application process generally follows these steps:

1. Shop around for a loan: Prequalify with multiple lenders to compare interest rates, terms, fees, and other factors without affecting your credit score.
2. Submit an application: Apply with your chosen lender for your desired loan amount. Provide required documents, including identity verification, income and employment proof, and financial information. Most online lenders provide instant decisions, though some take longer.
3. Review the loan offer: If approved, carefully read the loan terms and conditions before accepting the offer.
4. Receive your funds: Once you accept, the lender transfers your money as a lump sum via direct deposit or check.

After receiving your loan, you can use the funds for nearly any purpose not specifically restricted by the lender. You'll make fixed monthly payments until the loan is fully repaid.

Personal Loan Interest Rates and Fees

Personal loans come with several costs you should understand:

• Annual percentage rate (APR): The total yearly cost of borrowing, including interest and fees, expressed as a percentage. This is what you pay the lender for providing the loan.
• Origination fee: A one-time fee (typically 1-5% of the loan amount) charged for processing your application. This fee is usually deducted from your loan proceeds, so factor it into how much you need to borrow.
• Late fees: Charges are applied when you miss payment due dates or grace periods. Some lenders don't charge late fees, so compare this when shopping.
• Prepayment penalties: Some lenders charge fees for paying off your loan early, typically calculated as a flat fee, a percentage of the remaining balance, or a few months of interest.

What Affects Your Interest Rate

Your APR depends on several factors, including:

• Credit score: Higher scores qualify for lower rates
• Income: Higher income may result in better rates
• Debt-to-income ratio: Lower DTI typically means lower rates
• Loan amount and term: Shorter terms usually offer lower rates but higher monthly payments

How to Calculate the Total Loan Cost

When evaluating the cost of a personal loan, take a look at the amortization schedule—a table that lists each monthly payment from the time you take out the loan until it is paid off.

You can see how much of your payment goes toward the loan balance and how much goes toward the principal. Your lender may provide you with an amortization schedule, or you can create one yourself online.

It’s also a good idea to look at the total loan costs and interest paid. For example, if you borrow $5,000 on a 36-month personal loan with a 10% APR, the monthly payment will be $161.24, the total cost to repay the loan will be $5,508.24, and the total interest paid will be $808.24.

Am I Eligible for a Personal Loan?

Lenders evaluate your eligibility using the same factors that determine your interest rate: credit score, income, employment history, debt-to-income ratio, and loan details. For secured loans, they'll also appraise your collateral to determine its value.

How to Improve Your Personal Loan Approval Chances:

• Improve your credit score: Borrowers with good to excellent credit (670+) qualify more easily and receive lower interest rates. Pay down debts and make all payments on time to boost your score.
• Shop around with multiple lenders: Different lenders have varying credit requirements. If you have fair credit, specifically look for lenders that work with lower credit scores.
• Gather required documents: Prepare identification, proof of income (W-2s, paystubs, 1099s), address verification, and bank account information for direct deposit to streamline your application.
• Consider a co-signer: Some lenders allow co-signers or joint applicants. Adding someone with good credit can significantly improve your approval odds and potentially lower your interest rate.

"If you have a low credit score and several unpaid debts on your credit reports, this will factor into the terms of your personal loan agreement. If you have a long negative credit history, you will find it hard to get approved for a personal loan because the likelihood of you paying it back is low," says Hishaw.

Choosing the Right Personal Loan Lender

You have several lender options, each with distinct advantages:

• Traditional banks and credit unions: Offer in-person service and may provide relationship discounts, but typically have slower processing times
• Online lenders: Feature quick applications with decisions in minutes and funding within 1-2 days, though they offer limited banking services

Pro tip: Use pre-qualification tools to see preliminary offers without affecting your credit score. Compare rates and terms from several lenders, including your current bank or credit union if you have an existing relationship.

When comparing lenders, consider the following factors:

• Interest rates: The higher the interest rate, the more you pay for the loan. Look for lower APRs (but make sure to consider other factors).

• Loan terms: Personal loans often have repayment terms ranging from two to five years, but some lenders have shorter or longer loan terms available.

• Fees: Look at loan origination fees, late payment fees, prepayment penalties, and other costs associated with the personal loan.

• Loan amounts: Lenders offer personal loans that fall within specific loan amounts. Look for a lender that offers loans in the amount you need.

• Monthly payments: Check the monthly payment—a loan that you can’t afford to pay won’t do you any good.

• Lender reputation: Research lenders on third-party sites like Trustpilot and the Better Business Bureau. Look for recent headlines about the lender’s business practices, and watch out for any regulatory or reputational issues.

“The Consumer Financial Protection Bureau and Better Business Bureau are all great resources to determine if the personal loan lender is reputable. Also, conducting an internet search to check out if the lender has violated the Fair Debt Collection Practices Act is another indicator to determine if the lender is good or bad,” says Hishaw.

Pro tip: If something sounds too good to be true, it could be a scam. Watch out for any lenders that make bold claims, have unusually low interest rates, or ask for money up front to secure a loan before you even apply.

How to Manage Your Personal Loan Responsibly

Once you get a personal loan, you'll need to manage it responsibly to protect your finances and your credit. If you have a secured loan, missing payments could cause you to lose your collateral. Use these strategies to manage your loan responsibly:

• Make on-time monthly payments: Timely payments avoid late fees, prevent default, and can improve your credit score over time. Set up automatic payments or calendar reminders to never miss a due date.

• Budget for your loan payment: Ensure that there's room in your budget for your monthly payment, even if you have to move some things around. Don’t borrow more than you can reasonably afford to pay.

• Pay above the minimum: Want to pay off your loan faster? Put a little extra toward your loan each month. You’ll shrink your number of payments, save money in interest, and close out the loan quicker (just make sure you know if there are any prepayment penalties).

“You should only take out the loan amount that you need. Most of the personal loan lenders do charge higher interest rates than a standard home loan lender, so it's important to keep the amount you borrow low,” says Hishaw.

Conclusion

Personal loans offer flexible financing with fixed rates and predictable payments, making them ideal for debt consolidation, home improvements, and major expenses. Success depends on choosing the right lender, borrowing only what you need, and making timely payments to protect your credit and financial health.

Frequently Asked Questions

What credit score do I need to qualify for a personal loan?

Most lenders require a minimum credit score of 580-650, though some work with scores as low as 500. Borrowers with scores of 670+ typically qualify for the best rates and terms.

How quickly can I get funded after approval?

Online lenders often fund loans within 1-2 business days, while traditional banks and credit unions may take 3-7 days. Some lenders offer same-day funding for an additional fee.

Can I pay off my personal loan early without penalties?

Many lenders allow early payoff without penalties, but some charge prepayment fees. Check your loan terms before signing and ask specifically about prepayment policies when comparing lenders.