A personal loan is money taken from a lender that you repay in monthly installments.
A personal loan is money taken from a bank, credit union, or online lender that you repay in fixed monthly payments, or installments, usually over two to seven years.
While it’s usually best to invest in your savings or emergency fund to cover unexpected expenses, personal loans can be a good option for non-discretionary purposes, such as debt consolidation.
How do personal loans work?
Most personal loans are unsecured, meaning they are not backed by collateral. Lenders decide whether to grant you an unsecured loan based on factors such as your credit score, credit history, debt-to-income ratio, and free cash flow.
If you don’t qualify for an unsecured loan, you may be offered a secured or co-signed loan. Secured loans are backed by an asset like your home or car, and the lender can repossess your assets if you default. Co-signed loans involve an additional applicant with a strong credit profile who will help guarantee the loan; They are responsible for missed payments.
Other types of personal loans include fixed-rate loans, in which your rate and monthly payments stay the same, or variable-rate loans, in which your rate and payments change.
How to choose the best personal loan
One of the best ways to evaluate a personal loan is to look at the annual percentage rate of the loan. The APR is the total cost of borrowing and includes interest and any fees.
For example, if you take out a $10,000 personal loan at 15.5% APR, with a 24-month repayment term and monthly installments of $487, you’ll pay a total of $1,694, according to NerdWallet’s personal loan calculator.
Lender rates can range from around 6% to 36% APR. You’ll want to compare rates from several lenders before applying. The loan with the lowest APR is the least expensive and usually the best option.
How personal loans affect your credit score
A personal loan affects your credit score like any other type of credit. On-time payments will build credit, while late payments can hurt your score if they are reported to the credit bureaus.
Your score will also be affected by applying for the loan. Most lenders allow you to pre-qualify with a soft pull, which won’t hurt your score. Once pre-approved, formally applying begins a hard stretch, which typically takes five points off the score and stays on your credit report for up to two years.
What can I use a personal loan for?
Personal loans can be used for almost any purpose. Common uses include debt consolidation, home improvement projects, medical bills, and refinancing existing loans.
The loan can also be used for other purposes, such as paying for a wedding, vacation, or other large purchases.
When to use a personal loan
A personal loan should help you reach your financial goals rather than contribute to a debt problem, which is why we recommend using it only if it saves you money, improves your income-generating capabilities, or helps to increase the value of something you own.
For example, a home improvement project may increase the value of your home, and a loan may make sense if you don’t have much equity in your home or don’t want to use your home as collateral.
Personal loans can also be a smart way to consolidate multiple debts if the loan has a low-interest rate. With this type of loan, you will use it to pay down your outstanding balance, then make fixed monthly payments towards the personal loan.
Personal Loan Options
For discretionary expenses, consider cheaper options than a personal loan.
A 0% APR credit card can be one of the best ways to borrow money, especially if you pay the balance in full within the card’s introductory period. This period can last up to 21 months and no interest will be charged on your purchases.
You need good to excellent credit – above 690 FICO – to qualify for the 0% card.
A personal line of credit is another option. These are usually offered by credit unions and banks and are a hybrid between a loan and a credit card. Like a loan, a lender will need to approve your application, but like a credit card, you only draw on what you need and only pay interest on the amount you use.
A line of credit is ideal for borrowers who are not sure what their total borrowing requirement will be. Those with good or excellent credit have the best chance of getting approved for the lowest rates.
How do I get a personal loan?
A strong credit profile gives you a better chance of qualifying for a personal loan and getting a lower interest rate. However, there are lenders that offer fair credit and bad credit loans.
Some lenders prefer alternate data when evaluating applicants, including education, occupation, and where you live, or do nothing at all on your credit report.
apply for a personal loan
You can usually apply for a personal loan in just a few steps.
First, you’ll want to pre-qualify with several lenders to compare offers. Pre-qualifying only takes a few minutes, and will require you to provide information such as the purpose of the loan, loan amount, desired monthly payment, and your basic personal details.
After you have selected the best offer, you will collect documents for a formal application. This usually includes a photo ID, proof of address, proof of employment status, education history, financial information, and your Social Security number.
Most lenders now have a completely online application, so you can complete your application from a desktop or mobile device.
Once you’re approved, you can get funded as quickly as the same day.
pay back a personal loan
Personal loans are like any other loan: you need to have an understanding of how the monthly payments affect your budget and a clear plan to repay the loan.
This may mean reviewing your budget and adding to your monthly payment, as well as keeping an eye out for any refinancing opportunities to take advantage of a lower rate.