A personal loan is a relatively flexible loan to be used for short-term financial needs when you don’t want to dip into your savings. Keep reading to learn exactly how they work and what you can afford to do with this type of loan.
What is a personal loan?
A personal loan is money borrowed from a financial institution (think bank, credit union or online lender) that you pay back in fixed monthly payments.
This type of loan typically lasts between two to seven years. It’s a good option if you don’t want to rely on your savings account to cover unexpected expenses or for any non-discretionary purposes, such as debt consolidation.
How do personal loans work?
Personal loans can be relatively easy to qualify for and are based off of your credit history and income.
The money can be used for almost anything, including expensive purchases or medical bills. You might also see them referred to as signature loans or unsecured loans because there is usually no collateral required to secure one (but more on that later).
Once you receive the loan, the money is typically given in one lump-sum that you repay with fixed monthly payments, plus interest (of course@!)
The interest rate — or Annual Percentage Rate (APR) — is determined by your credit score. Higher credit scores will give you better interest rates, since your risk as a borrower is calculated using your credit score.
The interest rate is typically fixed throughout the payment period. However, some lenders have different rules so be sure to check your terms to confirm that your rate won’t change in the repayment process.
Secured vs. Unsecured personal loans
The majority of personal loans are unsecured, meaning they aren’t backed by collateral and a lender decides whether or not to give you the loan based on your credit score, history, and income.
Collateral can be any asset that is able to be seized and sold to repay the loan (if necessary). If you can’t get an unsecured loan, your next option is a secured loan, which is backed by collateral, like your car or house.
What can I use a personal loan for?
Personal loans are very flexible in terms of what you can use them for. Here are a few examples:
- Debt consolidation (most commonly for credit card debt)
- Home improvement projects
- Medical bills
- Refinancing existing loans, or repaying family and friends
- Special occasions such as weddings or funerals
- Small business expenses
- Vacations and holiday shopping
- Divorce costs
- Moving expenses
How to get a personal loan
The process of applying for a personal loan usually involves three steps.
- First, pre-qualify for the loan with multiple lenders. This way, you can compare interest rates and repayment plans. You’ll need to provide information regarding the loan’s purpose, how much you want the loan to be, your ideal monthly payment, and your personal financial information (credit score, history, income, etc.).
- Then, select the best offer. Once you decide what’s best for you, you’ll submit a formal application with the lender. This includes a photo ID, proof of address and employment, your financial information and Social Security number.
- Once approved, you’re all set! And your lender could give you the money as early as the same day as applying.
If you have bad credit:
A strong credit score will give you a better chance of qualifying for a personal loan, having a simpler time applying for one, and give you a better interest rate.
That said, there are lenders who cater to people with bad credit profiles. If you don’t have time to improve your credit before applying for a personal loan, talk to your lender to see if they offer a fair credit or bad credit loan. These will have higher rates, but they’re available to people in a sticky financial situation.
Do personal loans affect my credit score?
Yes, just like any other kind of loan! If you make your personal loan payments in full and on time, this will help improve your credit score. Late or missed payments, on the other hand, will significantly damage your score.
How many personal loans can you have at once?
It depends on the lender. With some lenders, you can have multiple personal loans with them or even across different lenders. But, a lender could limit the amount of money they’ll give you because you may already have too much existing debt. Generally speaking though, there is no law against having a certain number of personal loans at once.
Can you refinance a personal loan?
Yes, it’s possible to refinance a personal loan. When you do this, you replace the existing loan with a new one to hopefully save money and qualify for a lower interest rate than you originally had.
Can you transfer a loan to another person?
Because a personal loan is determined by a person’s credit score and financial history, they generally cannot be transferred to another person. If your loan has a cosigner or guarantor, it is possible for that person to become responsible for the loan if you default. Doing so though would cause a lot of damage to your credit score.
What happens to personal loans when the borrower dies?
If a personal loan is still not paid off by the time the borrower dies, then the borrower’s estate is responsible for the remaining balance of the loan. If the loan had a co-signer, then that person would be in charge of paying off the loan.