A personal loan is exactly what it sounds like: money that you borrow from a bank, credit union, or online lender, which you can use for almost anything. Whether you need cash for a wedding, home improvements, debt consolidation, or just covering an emergency expense, a personal loan could be a solution.
How Does A Personal Loan Work From A Bank?
How To Apply For A Personal Loan
So,
How Does A Personal Loan Work
Here’s how it generally works: You borrow a certain amount of money from a lender, and they give it to you upfront. You are required to repay the loan with interest and repay it over a period of time. This means you’ll be paying back a little more than what you borrowed. The interest rate can vary based on factors like your credit score, income, and the lender’s policies.
For example, let’s say you borrow $10,000 at an interest rate of 7% for 3 years. Over time, you’d repay the loan in monthly installments, which would include both the principal (the amount you borrowed) and interest (the cost of borrowing). In the end, you would have paid back more than $10,000—usually a few thousand dollars more.
Types of Personal Loans
Personal loans can be used them for anything. Let’s see the main types of personal loans so you can figure out which one works best for you.
Unsecured Personal Loans
First up, we have unsecured personal loans. These are the most common types of personal loans, and they’re also the easiest to get because you don’t need to put up any collateral—like your car or house—to secure the loan. The lender just looks at your credit score, income, and other factors to decide if they’ll approve you.
The downside? Since they’re not backed by any assets, they tend to have higher interest rates compared to secured loans.
For example, if you’re using this loan to consolidate credit card debt, you’ll probably pay more in interest than if you had a secured loan. But if you’ve got good credit and need a bit of extra cash, an unsecured loan can be a fast and straightforward solution.
Secured Personal Loans
Next, let’s talk about secured personal loans. As the name suggests, these loans require you to provide some sort of collateral. This could be your car, your house, or even savings in a bank account. In the event that you can’t repay the loan, the lender can take your collateral to recover their money.
Because the lender’s risk is lower with a secured loan, you’ll typically get a lower interest rate. However, if you can’t make the payments, you risk losing whatever asset you’ve pledged as collateral. So, make sure you’re confident you can repay before going this route.
For example, if you have a car you own outright, you could get a secured personal loan using your car as collateral. If you need the money for something like home improvement, this might be a good option since you’ll likely get a better deal on interest.
Debt Consolidation Loans
If you’re juggling multiple debts, you might want to consider a debt consolidation loan. These are a specific type of personal loan designed to combine all your debts into one. This can make your monthly payments easier to manage because you’ll have just one loan and one payment instead of several.
For instance, let’s say you have a few credit cards, a medical bill, and a personal loan. If you consolidate those into a single loan with a lower interest rate, it can save you money in the long run. Keep in mind, though, that debt consolidation works best if you can get a lower interest rate than what you’re currently paying across all your debts.
Fixed-Rate Personal Loans
In the case of personal loans with fixed rates, the interest rate remains the same for the entirety of the loan’s amortization period.. This means your monthly payments won’t change, which can be really comforting if you want to know exactly what you’re paying each month.
These are perfect for people who like stability. For example, if you’re planning a big purchase like home renovations or a wedding, a fixed-rate loan can give you peace of mind that your payments will remain the same throughout the term of the loan.
Variable-Rate Personal Loans
In contrast, variable-rate personal loans have interest rates that can change over time, often tied to an index or benchmark rate, like the prime rate. If the benchmark rate goes up, your interest rate will likely go up too, which means higher monthly payments. If the rate goes down, your payments may become more affordable.
These loans can be a good option if interest rates are low and you expect them to stay low. However, there’s more risk involved since your payments can increase if rates go up. For example, if you take out a loan with a low initial rate and then the prime rate increases, your monthly payment could suddenly go up, making it harder to budget for.
Payday Loans
Payday loans are short-term loans that are designed to be paid off with your next paycheck. They’re typically for small amounts, but they come with extremely high-interest rates and fees. You’ll usually need to repay the loan in full within a couple of weeks.
While payday loans can be tempting because of how fast and easy they are to get, they are really expensive in the long run. If you’re in a pinch and need cash right away, a payday loan might seem like an option, but be careful. The fees can pile up quickly, and you could end up in a debt cycle that’s hard to escape from.
Co-Signed Personal Loans
Sometimes, you might not have the credit history or income to qualify for a loan on your own. In that case, a co-signed personal loan might be an option. This type of loan involves having someone else (usually a family member or close friend) sign on the loan with you. If you can’t make the payments, the co-signer is responsible for paying it back.
A co-signed loan can help you get a better interest rate if your credit isn’t great, but it’s a huge responsibility for both you and the co-signer. If you miss a payment, it could affect both of your credit scores. It’s a good option if you’re sure you can repay the loan, but be cautious about putting someone else’s credit at risk.
Specialty Loans (Medical, Home Improvement, etc.)
Some personal loans are designed for specific purposes, and they may offer perks like lower interest rates or longer repayment terms. For example, if you need a loan for medical expenses, a medical loan might be a good choice.
These loans are specifically for healthcare-related costs and often come with lower rates than a general personal loan.
Personal Loan Advantages and Disadvantages: What You Should Know
Thinking about taking out a personal loan? Before you dive in, let’s take a look at the advantages and disadvantages.
Advantages of a Personal Loan
Here are the advantages:
Lower Interest Rates (Than Credit Cards)
One of the biggest perks of a personal loan is that it often comes with lower interest rates compared to credit cards. If you’ve ever had credit card debt, you know how high those interest rates can be—sometimes 20% or more! A personal loan, on the other hand, might offer you a rate of 6%, 7%, or 8%, depending on your credit score.
Let’s say you have $5,000 in credit card debt with a 20% interest rate. If you took out a personal loan at 7%, you could save a significant amount of money in interest over time, which means more of your payments actually go toward paying down the debt rather than just covering interest.
Predictable Monthly Payments
With a personal loan, you get fixed monthly payments. This is super helpful because you know exactly how much you’ll need to pay each month and when the loan will be paid off. It makes budgeting easier. Whether it’s $150 or $500 a month, you don’t have to worry about fluctuating payments like you do with credit cards, where the balance—and your payment—can change depending on what you owe.
For example, if you take a personal loan to pay for a wedding, you’ll know exactly what your monthly payments will be, which helps you plan your finances more easily. No surprises!
Flexible Use of Funds
Personal loans are unsecured, meaning you don’t have to put up collateral like your house or car. You can use the money for almost anything—home improvements, debt consolidation, medical bills, or even a big vacation. As long as it’s legal, the bank doesn’t care what you spend the loan on.
This flexibility can be a huge advantage if you need a lump sum of cash for something important, like fixing a leaky roof or covering a wedding. It’s like having access to an emergency fund, without actually having one sitting in your savings account.
Debt Consolidation
If you’re juggling multiple debts, a personal loan can be a great way to consolidate them into one monthly payment. Consider the following scenario: you have many credit cards, each of which has a variable interest rate. You can use a personal loan to pay off those cards and then make one monthly payment at a potentially lower rate. This can simplify your finances and might even save you money in the long run.
Disadvantages of a Personal Loan
Here are the disadvantages:
Interest Rates Can Be High for Low Credit Scores
While personal loans generally offer lower interest rates than credit cards, if you have a poor credit score, you might not get the best deal. In fact, if your credit is on the lower end, the bank could offer you a loan with a much higher interest rate—or even deny you altogether.
For example, if you have a credit score in the 600s, you might only qualify for a loan with an interest rate of 15% or higher. Because of this, it is possible that you may wind up paying a much higher amount for the loan over the course of its duration.
Fees Can Add Up
Personal loans can come with fees—such as origination fees (a fee for processing the loan) or prepayment penalties (a fee for paying off the loan early). These fees might not be immediately obvious, so it’s important to read the fine print before signing anything.
Let’s say you get a $10,000 loan with a 5% origination fee. That means you’re actually only getting $9,500, but you’ll still be responsible for paying back the full $10,000 plus interest. So, fees like this can make a loan more expensive than you originally thought.
Can Lead to More Debt
While personal loans can help you pay off high-interest credit card debt or other loans, they can also lead to more debt if you’re not careful. If you borrow money to pay off old debt but don’t change your spending habits, you might find yourself in the same situation a year later, with even more debt to manage.
For example, if you consolidate credit card debt with a personal loan but continue to rack up credit card charges, you might end up with both a loan and credit card debt on your hands. So, it’s important to make sure you’re tackling the underlying cause of your debt, not just moving it around.
You Could Be Denied
If your credit score isn’t great, or if you don’t have a stable income, there’s a chance the bank will deny your loan application. Even if you’re approved, you might not get the amount you were hoping for, or the interest rate might be so high that it’s not worth it.
For example, if you’ve recently had a string of missed payments or are in between jobs, a lender might view you as a risky borrower and decide not to approve your loan.
What Is A Personal Loan Used For?
A personal loan is super flexible and can be used for almost anything! You can use it for big purchases, like buying a car or paying for a wedding, or for consolidating credit card debt. Some people take out personal loans to cover unexpected expenses, like medical bills or home repairs. Basically, if you have a need for cash and you don’t want to dip into your savings, a personal loan could be the solution.
7 Personal Loan Examples
Let’s take a look at 7 examples of how you might use a personal loan in real life.
Debt Consolidation Loan
If you have several high-interest debts, like credit card bills or store cards, a debt consolidation loan can be a lifesaver. The idea is to combine your debts into one loan, often with a lower interest rate. This can make your payments easier to manage and assist you in paying off your debt more quickly. For instance, imagine you have credit card debts totaling $5,000 with interest rates ranging from 18% to 25%. If you take out a debt consolidation loan at a 10% interest rate, you’ll pay less in interest and only have one monthly payment to manage.
Medical Loan
Medical expenses can add up quickly, especially if you don’t have insurance or if you need treatment that isn’t covered. A medical loan is a personal loan specifically designed to help pay for medical bills. Whether it’s for an emergency room visit, surgery, or dental work, this type of loan can ease the financial burden. For example, if you need an unexpected surgery and the cost is $8,000, a medical loan might allow you to pay it off over a couple of years instead of facing that huge bill all at once.
Home Improvement Loan
Thinking about upgrading your home? A home improvement loan can provide the funds you need to renovate your kitchen, fix the roof, or even add a new bathroom. If your home needs repairs or upgrades but you don’t have enough cash on hand, this loan can help you avoid draining your savings. For instance, if your air conditioner breaks down in the middle of summer and replacing it costs $3,000, a personal loan for home improvement can get you the funds to fix it quickly without waiting for months to save up.
Wedding Loan
Weddings can be expensive, and if you don’t have enough saved up, a wedding loan could help cover the costs. Whether you’re dreaming of a big celebration with all your friends and family or a smaller, intimate ceremony, personal loans for weddings can help make your day special. Let’s say your wedding costs around $20,000 and you’ve saved $5,000, but need the extra $15,000 to cover everything from the venue to the catering. A wedding loan could cover the gap, allowing you to pay it off over time while still enjoying your big day.
Vacation Loan
Everyone deserves a break! If you’ve been putting off a vacation because of the cost, a vacation loan might be the solution. With this type of loan, you can fund your dream trip without worrying about spending all your savings. For example, if you’ve always wanted to visit Europe but don’t have the funds to cover flights, hotels, and activities, a vacation loan could help. Let’s say the trip costs $7,000—by taking out a vacation loan, you can enjoy the vacation now and pay it back gradually once you return.
Auto Loan
While you can finance a car through a dealership, some people opt for a personal loan instead of a traditional auto loan. This gives you more flexibility and may offer better terms if you have good credit. With a personal loan, you can use the funds to purchase a new or used car, or even refinance an existing car loan. For instance, if you’re looking to buy a car for $15,000, taking out a personal loan instead of going through the dealer might give you a better interest rate or allow you to avoid paying for add-ons that dealers sometimes offer.
Small Business Loan
Starting a business or need capital to grow your existing business? A small business loan is another way to get the funding you need. While some business loans require collateral or a business plan, others may be easier to qualify for if you have good credit. For example, if you own a coffee shop and want to expand to a second location, a personal loan could help cover the cost of rent, equipment, or employees. Though it’s not a traditional business loan, using a personal loan for business purposes is fairly common, especially for small entrepreneurs.
As you can see, personal loans aren’t just for emergencies. They can help with everything from consolidating debt and paying for medical expenses to making big life events like weddings and vacations more affordable.
What Are Personal Loans Interest Rates?
Personal loan interest rates can vary based on factors like your credit score, income, and the loan amount. Typically, they range from about 6% to 36%. If you’ve got excellent credit, you might snag a low rate—think closer to 6% or 7%. But if your credit is on the lower side, your rate could be higher. Always shop around for the best rate, especially if you plan on borrowing a significant amount!
How Can I Get Approved For A Personal Loan?
Getting approved for a personal loan usually depends on your credit score, income, and debt-to-income ratio. Lenders want to see that you can pay back what you borrow. To increase your chances of approval, check your credit score before applying and try to pay down existing debts. If your credit score isn’t great, consider having a co-signer or applying for a secured loan where you put up collateral to reduce the risk for the lender.
How Much Would I Pay On A $5000 Personal Loan Per Month?
The amount of the monthly payment for a personal loan of $5,000 is determined by the interest rate as well as the length of the loan. For example, if you get a 10% interest rate on a 3-year loan, your payment might be around $160–$170 a month. If you go for a 5-year loan, your payment would be lower, but you’d end up paying more interest over time. To get a clear idea, use an online loan calculator based on your specific rate and term.
Does It Hurt To Get A Personal Loan?
Getting a personal loan doesn’t “hurt,” but it can affect your credit. When you apply, lenders do a hard inquiry on your credit report, which can temporarily lower your score by a few points. However, if you make your payments on time, it can improve your credit score in the long run. Just be sure you can comfortably repay the loan before applying, so you don’t get stuck with high-interest debt or late fees.
Do Personal Loans Have Fees?
Yes, personal loans can come with fees, though not all do. Common fees include origination fees (typically 1–6% of the loan amount) and late payment fees. Some lenders may also charge fees for early repayment, though many don’t. It’s super important to read the loan agreement carefully to know what fees apply. If you’re unsure, ask the lender for a breakdown of all potential charges before committing to the loan.
Conclusion
In conclusion, a personal loan offers flexibility and convenience, allowing you to borrow money for a wide range of purposes, from weddings to home improvements or even unexpected emergencies. With options available from banks, credit unions, and online lenders, it can be a practical solution for managing both planned and unplanned expenses. Just be sure to evaluate your financial situation, compare loan terms, and ensure that the repayment plan works within your budget before committing.