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What Is a Personal Loan? Your Guide To Loans

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Personal loans can help you borrow the money you need to invest in a personal purpose. For example, if you’re looking to consolidate debt, do a home renovation project, or cover some unexpected bills, taking out a personal loan lets you access the money you need upfront and pay it back over time. Personal loans, also known as consumer loans, provide immediate funding with flexible applications, and borrowers typically have options for paying them back over a short or moderate term. Use this guide to help you understand everything you need to know about personal loans.

What Is a Personal Loan?

A personal loan is money that you borrow from a bank or other financial institution, like a credit union or online lender, that you repay in regular installments over a defined period of time. It’s common for borrowers to pay back their loans through monthly installments over the course of several years. Often, borrowers pay off their loans within two to seven years of accepting the loan. The amount of money individuals take out can vary widely, from as little as $1,000 to more than $50,000. In addition to paying back the loaned money, borrowers also pay back interest.

What Are Personal Loans Used For?

There are many uses for personal loans. When you take one out, it’s up to you to use it at your own discretion. Here are some common uses for personal loans:

  • Consolidating debt: Individuals can choose a consolidating debt loan to help them merge and manage credit card debt or debt they may have from other loans. This is a type of unsecured loan, and these loans often have lower interest rates that make them easier to pay back.
  • Hosting a major event: If you’re planning a major event like a wedding, honeymoon, or celebration, you can take out a personal loan to help you cover the expenses. Then you can pay the loan back over time in regular installments after the event.
  • Improving your home: You can take out a personal loan to finance a small home renovation project. When choosing a loan for your next home project, you may prefer a personal loan, since these are unsecured and won’t require you to put your home up as collateral.
  • Investing in your education, career, and self: Taking out a personal loan can help you cover education expenses, such as pursuing a certification course to advance your career. (Note that some lenders prohibit you from using a personal loan to pay down student debt.) Personal loans may also allow you to cover the costs of cosmetic procedures.
  • Covering unexpected expenses: In the event of an emergency, you might take out a personal loan to cover unexpected expenses. For example, if you need a major medical procedure or to repair extensive damage to your home after a disaster, you can use a personal loan to cover your bills.

How Does a Personal Loan Work?

A personal loan works by the borrower submitting an application to their financial institution of choice to request approval for their loan. After approval, the financial institution deposits the money into your account and you start to pay off the loan. Personal loans are typically unsecured, which means borrowers don’t need to put up collateral when they take out a loan. However, in some cases, the financial institution may only offer a secured loan, which means you need to put down collateral in the form of cash or another valuable asset.

Borrowers also need to pay interest on their loans with each monthly payment. Interest rates can vary, but it’s common for them to be between 3% and 36%. In addition to interest, some loans may require an origination fee. This is a fee you pay on top of what you owe for the loan. Some origination fees can be as much as 6% of your loan amount, so make sure you’re prepared to pay this fee in addition to your monthly payments.

How Do Loan Providers Determine Rates?

Several factors influence how much your annual percentage rate (APR) will be for your loan. First, lenders typically base their rates on an index rate, which includes the prime rate. This rate refers to the rate at which other financial institutions lend to each other. Depending on whether you have a fixed or variable rate, your APR may change due to fluctuations in the index rate.

For example, if you have a fixed rate, your APR will stay the same for the entirety of your payment period. A variable rate may fluctuate with the index rate, but many lenders establish a cap that prevents your variable rate from getting too high. Another major factor influencing your APR is your credit score. Having a good credit score can qualify you for a lower interest rate. In addition to these factors, your APR may also account for:

  • Your annual income
  • Your history of making payments on-time
  • Your ratio of debt to income

How Do I Get a Personal Loan?

When applying for a personal loan, the first step is to pre-qualify with several different lenders. Pre-qualifying allows you to get offers from multiple institutions, which means you can compare your options and choose the best one for you. Once you’ve compared your options and selected one, you need to prepare your application. Applying involves gathering the necessary documentation to submit along with completing the application form. Some information you’ll likely need to submit includes:

  • Photo identification
  • Proof of employment status
  • Proof of address
  • Documentation of your educational history
  • Your financial information
  • Your social security number

After gathering all the information and verifying its accuracy, you can submit your application. Most financial institutions allow you to submit your application electronically, such as through their online webpage. The approval process typically takes a few hours, and you should receive your funds the same day you apply.

Taking out a personal loan can help you get the money you need to manage debts or meet your expenses. These loans offer flexibility to borrowers, but it’s important to do your research and only take out a loan if you can afford to pay it back. There are many tools available to help you calculate how much you can afford when taking out a loan, and you can also consider an alternative, such as opening a 0% interest credit card or getting a personal line of credit.

FIXD Research Team

At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.

We’re here to help you simplify car care and save, so this post may contain affiliate links to help you do just that. If you click on a link and take action, we may earn a commission. However, the analysis and opinions expressed are our own.


About the Author

FIXD Research Team

FIXD Research Team

At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.

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