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What Is a Personal Loan

What Is a Personal Loan

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updated: July 4, 2024
edited by Jill Cornfield

Whether you need to consolidate debt, pay for an unexpected home repair, or cover a medical bill, a personal loan could help. Personal loans typically have fixed interest rates and repayment terms of up to a few years. These loans can be used for almost any purpose. While this flexibility is useful, it’s wise to only apply for a personal loan if you have a necessary expense to cover.

Here’s what you need to know about personal loans, including how they work, their rates, how to qualify for one, and more.

How a personal loan works

Personal loans are a type of installment loan, as they usually have a fixed rate and a set repayment schedule. You’ll generally make fixed payments toward your personal loan each month, with the size of your payment depending upon your initial loan amount and repayment term.

Common features of personal loans

While personal loans can vary depending on your lender, here are some commonalities you’ll likely encounter.

  • Repayment terms. Most personal loans have repayment terms of a few years or less. Common terms are 12 to 60 or 84 months, and terms differ by lender.
  • Origination fees. Lenders often charge origination fees for personal loans. These fees cover the cost of loan origination and disbursement and are often deducted from your loan proceeds upfront. For instance, if your $5,000 has a 5% origination fee, you may only receive $4,750 in total loan funds.
  • Fixed rates. Personal loans typically have fixed interest rates, and those rates are often lower than you’d get with a credit card.
  • Fixed monthly payments. Since these loans have fixed rates, you’ll also have fixed monthly payments.
  • Unsecured. These loans can be secured by collateral, often a savings account, or unsecured. While a secured loan could be easier to qualify for, unsecured loans are more common.
  • Loan amounts. Personal loans range in size from a few hundred to tens of thousands of dollars and can vary significantly by lender.
  • Funding time. Unlike home equity loans or home equity lines of credit (HELOCs), personal loans are typically disbursed quickly. You’ll often receive your loan funds as soon as the same day of approval or a few days afterward.

How personal loan rates are determined

Individual lenders determine personal loan rates, which are influenced by the Federal funds rate—a target rate for which banks can borrow and lend to each other. When the federal funds rate increases, personal loan rates are likely to increase. The Federal Reserve sets the funds rate eight times a year.

Personal loan rates are partly influenced by your credit history. If you have excellent credit, your interest rate will likely be on the lower end of the available range. If your credit isn’t great, you may receive a higher rate.

What can I use a personal loan for?

You can use a personal loan for a broad range of purposes. Common uses include:

  • Debt consolidation.
  • Home projects.
  • Medical bills.
  • Family planning.
  • Moving expenses.
  • Unexpected costs.
  • Wedding expenses.

You can also use a personal loan to finance a vacation, though it’s a good rule of thumb to only apply for a loan to cover an essential cost. Some lenders place a few restrictions on personal loan uses, so that’s important to be aware of. Depending on the lender’s guidelines, you can’t use a personal loan for higher education costs or to invest. It goes without saying that you can’t use a personal loan for illegal activities or gambling.

Common mistakes when using a personal loan

If you’re considering a personal loan, avoid the following common mistakes to help ensure you don’t get over your head financially.

  • Not checking your credit. As mentioned, you’ll likely get the best rate on a personal loan if you have excellent credit. Check your credit before you apply to gain insight into potential rates.
  • Not getting prequalified. Many lenders let you prequalify for a personal loan. This involves sharing some basic personal and financial information. In exchange, prospective lenders share a potential loan amount and rate. Prequalifying can help you compare loan options.
  • Not comparing lenders. Applying for the first loan you come across is almost always a mistake, as you could end up with a higher-rate loan. Instead, you’ll want to compare loan amounts, rates, and repayment terms from different lenders to make an informed borrowing decision.
  • Borrowing too much. You might be able to qualify for a larger loan than you need, but it’s not necessarily a good idea. Borrowing too much could result in unanticipated financial strain.
  • Not paying your creditors. If you plan to use a personal loan for debt consolidation, pay your creditors promptly. This can help you avoid using your loan proceeds for unintended purposes.

When is a personal loan a good idea?

A personal loan could be a good idea for consolidating debt or covering another essential cost. These loans can help spread out your expenses over time, generally at lower rates than credit cards.

How to qualify for a personal loan

Different lenders may have different requirements for borrowers seeking a personal loan.

Generally, you’ll need to:

  • Be at least 18 years old.
  • Have a good credit score (670 or above).
  • Have a consistent monthly income.
  • Have a manageable level of debt (debt-to-income ratio, or DTI, below 36%).

How to get a personal loan

If you’re interested in a personal loan, there is no shortage of options available, and you can often apply online. The first step you’ll want to take is to compare loan options from different lenders. After that, you can narrow down your choices and apply for the best personal loan for your situation.

You’ll need to provide detailed personal and financial information during the application process. Your lender will likely ask for your name, address, email, phone number, Social Security number, employer and employer contact information, and monthly income. You may also need to provide copies of bank statements, W-2s, and past tax returns.

Once you’ve applied, your lender will do a hard credit check. This involves reviewing your credit report and score to assess your overall creditworthiness. A hard credit pull will cause your credit score to decrease by a handful of points.

After that, you’ll receive your loan decision. If approved, your lender should disburse your loan funds fairly quickly—often as soon as the same day, but sometimes within a few business days.

How to compare personal loan offers

As mentioned, comparing personal loan offers is crucial before applying for a loan. You’ll want to look at the following factors for an effective comparison.

  • Rates. Your interest rate is what you pay for the privilege of borrowing money. While personal loan rates are often lower than credit card rates, rates vary by lender. Comparing rates can help keep your borrowing costs as low as possible.
  • Fees. Likewise, fees vary by lender. Origination fees are common with personal loans, so you’ll want to understand those. Also, look out for application fees and other types of fees while you’re researching the options.
  • Loan terms. Personal loan terms often range from as short as 12 months to as long as 84 months. Look at loan terms to find one that best suits your situation.
  • Loan amounts. Different lenders offer different loan amounts. Some let you borrow as little as $500 or as much as $100,000.
  • Borrower requirements. Borrower criteria can also vary, though sometimes lenders aren’t forthcoming about credit score and income requirements. If so, consider contacting a loan officer directly to find more information.
  • Disbursement schedule. Disbursement times can be as soon as the same day you’re approved or within a few business days.

TIME Stamp: Before choosing a personal loan, learn all you can about the fees, rates, and terms

Personal loans offer flexibility, fast disbursement, and relatively low fixed rates. While there are many benefits to this type of financing, you’ll still want to compare loan options to find the best one for your needs. Consider rates, loan amounts, terms, fees, and requirements as you research potential lenders.

Frequently asked questions (FAQs)

Does it hurt to get a personal loan?

Lenders do a hard credit pull when you apply for a personal loan. This can result in minor damage to your credit score, but it’s usually temporary. Over the longer term, a personal loan may help boost your credit if you pay on time and in full each month. It could also make it easier to pay down high-rate debt.

Is a personal loan bad on your credit?

A personal loan is generally only bad for your credit if you don’t make the monthly payments or pay late. Your lender will report your payments to the major credit bureaus, and delinquencies can harm your credit score.

What are the benefits of a personal loan?

A major benefit of personal loans is that they can be used for almost any purpose. They have fixed interest rates and predictable payments, and they’re often disbursed within days of applying.

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