Personal Loans: What They Are and How to Choose Wisely

What is a personal loan?

A personal loan is a type of installment loan that provides a lump sum of money repaid in regular installments, typically with a fixed interest rate and fixed repayment term. The lender gives you the funds upfront, and you repay the loan over a set period, usually with monthly payments that include both principal and interest.

Personal loan amounts typically range from about $1,000 to $50,000 or more, depending on the lender. Because the loan is repaid in predictable installments, it can be easier to budget than revolving credit like a credit card, where the payment can vary based on your balance and interest rate.

• Lump sum payout: you receive the full loan amount at once
• Fixed interest rate: your rate stays the same for the loan term
• Fixed repayment term: you know exactly when the loan will be paid off
• Monthly installments: you make regular payments, usually once a month

Sources: National Council on Aging (NCOA), Forbes Advisor, Bankrate, Investopedia

How do personal loans work?

When you apply for a personal loan, a lender evaluates your creditworthiness based on your credit score, income, and debt-to-income ratio. If approved, you receive a lump sum and begin repaying it in fixed monthly installments over a set term. Your payment amount is determined by the loan amount, interest rate, and repayment term.

Lenders may offer both secured and unsecured personal loans. Most personal loans are unsecured, meaning they require no collateral. Secured loans, backed by an asset like a car or savings account, may come with lower interest rates and higher borrowing limits because the lender has additional protection. However, the risk of losing your collateral is real if you default.

During the application, the lender will likely perform a hard credit check, which can temporarily lower your credit score by a few points. Comparing lenders and getting pre-qualified can help you understand your options without an immediate hard inquiry.

• Unsecured loans: no collateral required, rates depend on creditworthiness
• Secured loans: backed by collateral, may offer lower rates and higher amounts
• Application process includes a credit check, income verification, and debt-to-income assessment
• Funds are typically provided as a lump sum

Sources: Federal Reserve Board, National Council on Aging (NCOA), Forbes Advisor, OneMain Financial, Bankrate, Investopedia

Types of personal loans

Personal loans can be broadly categorized as secured or unsecured, but they also differ by lender type and purpose. You can obtain a personal loan from banks, credit unions, and online lenders. Each type of lender may have different rates, terms, and fees.

Common uses for personal loans include debt consolidation, emergency expenses, home improvements, and major life events like weddings or moving. However, some lenders restrict how you can use the funds, such as excluding education costs or business expenses. Always check the lender's policy before applying.

• Unsecured personal loans: the most common type, no collateral needed
• Secured personal loans: require collateral, potentially lower rates and higher limits
• Lender types: banks, credit unions, online lenders
• Common uses: debt consolidation, emergencies, home improvements, major purchases
• Some lenders have restrictions: read the fine print on allowed purposes

Sources: Federal Reserve Board, National Council on Aging (NCOA), Forbes Advisor, OneMain Financial, Bankrate, Investopedia

Factors affecting loan costs

The cost of a personal loan depends on the interest rate, origination fees, and other charges. Interest rates for personal loans generally range from about 6% to 36% APR, though the rate you receive depends on your creditworthiness and market conditions. For current rate information, see our personal loan rates page.

Lenders may charge an origination fee, which is usually deducted from the loan amount (typically 1% to 8% of the loan). Other potential fees include late payment penalties and prepayment penalties, which some lenders impose if you pay off the loan early. These fees add to the overall cost of borrowing, so it's important to consider the APR, which reflects the total cost including fees.

Repayment terms typically range from one to seven years, with common terms of two to five years. A longer term means smaller monthly payments but more interest paid over the life of the loan. A shorter term has higher monthly payments but lower total interest cost.

• Interest rate: typically 6%–36% APR depending on credit and market
• Origination fees: usually 1%–8% of the loan amount
• Other fees: late fees, prepayment penalties (varies by lender)
• Repayment term: usually 1–7 years, commonly 2–5 years
• Total cost: compare APRs, not just interest rates

Sources: National Council on Aging (NCOA), Forbes Advisor, Bankrate

How to compare offers

When shopping for a personal loan, it's essential to compare multiple lenders. Look at the interest rate, fees, total cost of the loan, and repayment term. Also, consider the lender's reputation and customer service. Comparing loan offers can help you find the most affordable option for your situation.

A simple way to compare is to look at the APR, which includes the interest rate plus any origination fees and other costs. A lower APR typically means a lower overall cost. However, also check the monthly payment, total interest paid over the life of the loan, and whether the lender charges prepayment penalties.

You can use a personal loan calculator (an online tool) to estimate monthly payments and total interest, or you can do the math yourself. Many lenders offer pre-qualification, which lets you see potential rates without a hard credit check. This can help you narrow down offers before applying.

• Compare APRs from at least three lenders
• Review fee schedules: origination, late, prepayment
• Check monthly payment and total loan cost
• Consider the repayment term: shorter terms mean higher payments but less interest
• Use pre-qualification to compare rates without hurting your credit score

Sources: National Council on Aging (NCOA), Forbes Advisor, Bankrate

Common uses and pitfalls

Personal loans are often used for debt consolidation, especially for high-interest credit card debt, because the loan may have a lower fixed rate. They are also used for emergency expenses such as medical bills or car repairs, home improvements, and major life events. However, they may not be appropriate for nonessential purchases or if the monthly payment will strain your budget.

One pitfall is taking on a loan with a high APR, which can increase your total cost significantly. Another is borrowing more than you need or extending the term to lower monthly payments, which may lead to paying more interest. Additionally, some lenders charge prepayment penalties, which reduce the benefit of paying off the loan early.

• Good uses: debt consolidation, emergencies, home improvements, major purchases
• Pitfalls: high APRs can make borrowing expensive, longer terms mean more total interest, prepayment penalties may apply
• Consider whether you can comfortably afford the monthly payments before borrowing

Sources: National Council on Aging (NCOA), Forbes Advisor, Investopedia

Getting started: application overview

If you're considering a personal loan, the first step is to check your credit report and score, as this will affect the rates you qualify for. Then, gather financial documents such as income statements, tax returns, and debt information. Next, research lenders—banks, credit unions, and online lenders—and compare their offers.

Once you've chosen a lender, you'll complete a formal application, which may require a hard credit check. The lender will review your application and, if approved, you'll receive a loan agreement with the terms. After you sign, funds are usually disbursed within a few days. Keep in mind that applying for a loan involves a hard credit check, which can temporarily lower your credit score.

Start by comparing pre-qualification offers from multiple lenders to see potential rates without a hard inquiry, then proceed with the most suitable offer. Always read the loan agreement carefully, including fine print about fees and prepayment penalties, before signing.

• 1. Check your credit score and report
• 2. Gather documents: income, debts, identification
• 3. Compare lenders: banks, credit unions, online lenders
• 4. Use pre-qualification to compare rates without hard credit checks
• 5. Apply formally: expect a hard credit check
• 6. Review the loan agreement and funding timeline

1. Check your credit score and financial situation.
2. Research and compare lenders and their loan offers.
3. Get pre-qualified from a few lenders to compare rates.
4. Choose the best offer and submit a formal application.
5. Review the loan terms and sign the agreement.
6. Receive the loan funds and begin making payments.

Sources: National Council on Aging (NCOA), Forbes Advisor, OneMain Financial, Bankrate, Investopedia