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Personal Loan Definition, Types, and How To Get One

What is a personal loan?

Understanding a Personal Loan

Different types of personal loans

What is a Personal Loan?

An example of a personal loan

Where to Find Personal Loans

By Rebecca Lake

Updated August 09, 2021.

Review by Thomas Brock

Fact confirmed by Katrina Munichiello

What Is a Personal Loan?

The term “personal” refers to a loan is an amount of money that you can get to use for many different purposes. You could, for instance, use the personal loan to pay off your debt, fund home improvements, or to make plans for a wedding you’ve always wanted. Personal loans are offered by credit unions, banks, or online lenders. The money you borrow is due to be paid back over time, usually with interest. Some lenders will additionally charge fees to personal loans.

Important Takeaways

Individual loans are loans which can be used to pay for a number of personal expenses.

You can find personal loans through banks, credit unions, and online lenders.

Personal loans can be secured, meaning that you need collateral to borrow money, or unsecure, with no collateral needed.

Personal loans aren’t the same in regards to interest rates and fees, the amount, and the terms of repayment.

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Understanding a Personal Loan

A personal loan allows you to borrow money to pay for personal expenses, and then pay back the money over time. A personal loans are a kind of installment loan that allows you to obtain an amount of money in one lump. For instance, you could take advantage of the personal loan to cover:

Moving expenses

Consolidation of debt

Medical bills

Wedding expenses

Home improvements or repairs

Funeral expenses

Vacation costs

Unexpected expenses

These loans are distinct from other installment loans–such as student loans or car loans, and mortgage loans–that can be used to finance specific expenditures (i.e. education, vehicle purchase, and the purchase of a home).

Certain personal loan lenders limit the ways in which you can use the personal loan. For instance, you might not be able to get a personal loan to cover tuition fees, college tuition or any other costs.

The personal loan is distinct from a personal line of credit. The latter is not a lump sum , but it is more similar to credit cards. It is a credit line that can be used to make purchases and, as you spend it your credit line is reduced. Then, you can get credit back through a repayment to your credit line.1

With personal loan generally, there’s a fixed end date when the loan is paid back. Personal lines of credit, however is open to you for a long time until your account remains at a good state with your lender.2

The types of personal loans available

Personal loans can be secured or unsecured. Secured personal loan can be described as one which needs some kind of collateral as a condition of the borrowing. For example, you could secure the personal loan using cash assets such as a savings account or certificate of deposits (CD), or with an actual asset like your car or boat. If you default on the loan the lender can keep your collateral as a way to settle the loan.

A personal loan does not require collateral to borrow money. Credit unions, banks and online lenders are able to offer secured and unsecured personal loans to qualified borrowers. The banks generally view the latter as more risky than the former because there is no collateral to be able to collect. That can mean paying an interest rate that is higher for personal loan.3

How a Personal Loan Works

To obtain a personal loan then you must apply to the lender. Again, this can be an institution like a credit union, bank or an the internet-based personal loan lender.

In most cases, you’ll first fill out an application. The lender will review the application and decides if they want to accept or deny it. If it is approved, you’ll be provided with the loan terms which you may decide to accept or not. If you agree to them, the next step is the finalization of the loan documents.

After that then the lender will then fund the loan which is the process of paying you the proceeds. Depending on the lender, these may be paid by direct deposit to your account at a bank or the form of a check. After the loan is approved, you can use the money as you see suitable. After that, you’ll have to start repaying the loan according to the terms stipulated in the loan agreement.

Defaulting on a personal loan can cause serious damage to your credit score. It is also possible to lose your collateral with a secured loan or risk being sued by your lender in order to collect the loan.

A Personal Loan Example

If you’re considering a personal loan it is important to know what it may cost. Annual percentage rates (APR) on a personal loan is the cost per year of repaying the loan according to the interest rate and fees. The APR and loan term determines the amount you pay in interest total over the duration of your loan.

As an example, suppose you take out a personal loan with an APR of 7.5%. The loan comes with a repayment period for 24 month. Based on these terms your monthly payments is $450. The total interest paid over the course of the loan will be $799.90.

Imagine that you take out the same amount but with different loan conditions. Instead of a two-year loan the loan has a term of three years to repay the loan, and your rate of interest is 6% instead of 7.5%. With these guidelines, your monthly payment would be reduced to $304 however, your total interest would increase to $951.90.

This method of comparing numbers is important in order to make the lowest monthly payments or pay the least amount of interest when you take out an individual loan. A simple internet-based personal loan calculator can help figure out what type of installment amount and interest rate is the best choice to your budget.

While some lenders don’t charge fees for personal loans However, other lenders may charge fees for credit checks, the loan origination fee, or–if you decide to repay the loan early–a prepayment penalty. In the event of a late payment, it could result in an additional late payment charge.

How to find Personal Loans

The first place to search for personal loans may be your current bank or credit union. Your personal banker can inform you on what types of personal loans could be available, as well as the loan options that you’re most likely to qualify.

Personal loans can also be found on the internet. Numerous lenders offer individuals with loans online. You can apply electronically, get a decision in just a few minutes and, in certain instances, receive funds within 24 to 48 hours after loan approval.

When comparing personal loans online or off take note of the specifics. Particularly, think about the following:

Rate of interest

Fees

Repayment terms

Limits for borrowing (minimum and maximum)

Collateral requirements

You can check your credit report for free at AnnualCreditReport.com. While doing this, check for any errors that could affect your credit score, and do not hesitate to challenge these.

It’s also a good idea to look up the minimum requirements required to be eligible for a personal loan. Different lenders have different requirements in relation to credit score, income, and debt-to-income ratios that can be approved for personal loan. This can help you identify the loans that are most suitable for your financial and credit history.