How Do Personal Loans Work?

Advertiser Disclosure

Student Loan Hero Advertiser Disclosure

Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print to help you understand what you are buying. Be sure to consult with a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time.

Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by the financial institution.

how do personal loans work
Logo

OUR PROMISE TO YOU: Student Loan Hero is a completely free website 100% focused on helping student loan borrowers get the answers they need. Read more

How do we make money? It’s actually pretty simple. If you choose to check out and become a customer of any of the loan providers featured on our site, we get compensated for sending you their way. This helps pay for our amazing staff of writers (many of which are paying back student loans of their own!).

Bottom line: We’re here for you. So please learn all you can, email us with any questions, and feel free to visit or not visit any of the loan providers on our site. Read less


There’s no shame in needing an extra infusion of cash to make things work. Businesses do it all the time as a strategic move, taking out business loans to ensure smooth operations or grow into new areas. As an individual, you may have strategic reasons for borrowing, too, and luckily there’s a type of lending just for you — a personal loan. If you’ve heard of personal loans, you may wonder, “How do personal loans work?”

Personal loans are offered by banks and online lenders, and can be used for a wide variety of needs, from making a home repair to paying for dental work. While it’s important to be careful not to become overextended in your borrowing, personal loans can open up new possibilities, act as a lifeline in tough situations and even help you repair your finances when you’re badly in debt.

The personal loan landscape is very active, with a wide range of lenders competing for borrowers. This means that you’re likely to be able to find a loan product that will work for you, even if your credit score leaves something to be desired. For those with good or excellent credit borrowing is often affordable and easy.

What is a personal loan?
Uses for a personal loan
The different elements of a personal loan
Applying for a personal loan: An overview
Conclusion

What is a personal loan?

A personal loan is a fixed amount of money given to an individual by a bank or other lender that comes with a fixed interest rate and a fixed repayment term.

Personal loans are unsecured, which means that there is no collateral involved. Because of that, the lender has little recourse if you don’t pay the loan back: they can’t, for instance, repossess your car the way they could if you failed to pay a car loan for which the vehicle served as collateral. Because the lender has no recourse, personal loan interest rates tend to be relatively high compared to secured loans.

Uses for a personal loan

Personal loans are extremely flexible; they can cover almost anything assuming you have a credit score that will inspire a lender to take a bet on you. There are many solid reasons for borrowing a bit of cash, including replacing an appliance, covering medical costs and paying for unexpected emergency expenses, to name just a few.

There are two rules of thumb to keep in mind when taking out personal loans:

  1. Only borrow money you know you will be able to pay back in a timely manner.
  2. Don’t increase your debt load for insufficiently important reasons.

Taking out a loan when you have no extra income to pay it back over time is a mistake — a potentially very costly one. It’s also probably not a good long-term financial strategy to pay for vacations, gifts or other luxuries with borrowed funds, even if you can pay the loan back on schedule. Instead, you could invest that money you’re paying in interest on the loan, improving your overall financial outlook.

One of the most common — and most strategic — reasons to take out a personal loan is to reduce higher-interest debt. Indeed, upwards of 60% of personal loans are used to consolidate debt or refinance credit cards, according to a study by LendingTree, which owns Student Loan Hero. Consolidating debt means paying off several debts with one new loan that has an interest rate lower than the average of the loans being paid off.

This tactic is intended to lower the overall interest you are paying on your debt, thereby reducing the amount you’ll end up paying and/or the time it takes to pay it off. You can use an online credit consolidation calculator to figure out exactly how much you could save. Consolidating debt also results in a single payment due every month instead of a cascade of payments, making managing your debt that much easier.

The different elements of a personal loan

The details of personal loans shift depending on the details of the situation, such as the borrower’s credit score, the amount being borrowed and the lender’s rate schedule. Here are some of the elements of a personal loan to consider as you’re shopping around:

  • Interest rate: The interest rate, usually given as a percentage of the loan amount, is the amount you will pay on top of the principal of the loan. Interest rates for personal loans are usually fixed, meaning that the rate stays the same throughout the life of the loan. On occasion, rates can be adjustable, meaning they’ll fluctuate.
  • APR: The APR is the interest rate plus other fees that you must pay per year to borrow the loan, such as origination fees and service charges. This is basically the total annual cost of borrowing the money, and it can range from very reasonable to extremely high, depending on your credit score, typically varying between 7% and nearly 136%. In 2018, the average APR on personal loans was 33.52%, according to LendingTree.
  • Borrowing minimum/maximum: Lenders will often have floors and caps on how much they will lend in a personal loan. Typical personal loans range between $1,000 and $35,000, with some lenders offering much higher amounts to those with good or excellent credit. The average personal loan amount borrowed in 2018 was $10,575.
  • Term length: The term length is the amount of time the borrower has to pay the loan back. Personal loans usually have a fixed term, which means that all your monthly payments will be the same. Terms range from just a few months to six years or even longer. Three-year loans are the most popular, a LendingTree study found.
  • Prepayment penalties: Some loans come with the stipulation that you’ll be charged penalties if you pay the loan back entirely before the agreed-upon term is up. If you think you may want to pay your loan back faster than you are required to, it’s important to look at whether the loan you’re agreeing to has any prepayment penalties attached.
  • Other fees: Lenders can attach a variety of other types of fees to their personal loans, including origination fees and service charges. An origination fee is an amount you pay at the beginning of your loan for getting it set up; these fees usually range from 1% to 6% of your loan amount. It’s important that you read the fine print to know what fees you are responsible for once you sign on the dotted line.

Applying for a personal loan: An overview

Applying for a personal loan is generally a fairly pain-free process, especially if you work with an online lender that prioritizes speed (though be forewarned — such lenders often have higher rates and fees).

The fact that each lender structures its loans in its own way and offers customized rates means it’s a good idea to shop around a bit before settling on a lender. A good strategy is to get prequalified with a few lenders. Many lenders only do a soft credit pull for this process, which doesn’t affect your credit score.

Once you are ready to apply for a loan, lenders will want to get a better sense of your money management skills and financial situation in order to decide whether to lend to you. Typically, you will be asked to provide a variety of information about yourself as well as documentation. Here are some of the factors lenders will want to know about:

  • Credit score and credit history: When you make a formal application (as opposed to a prequalification request), the lender will do a hard credit check to learn about your credit score and history. Many lenders have specific credit scores they need to see in order to lend to an applicant. Those with high credit scores will be eligible for larger loans at better rates. Those with a longer credit history will also fare well in the lending process.
  • Employment and income: The lender may ask for information about your employment and income, including recent tax returns, pay stubs or W-2s. For obvious reasons, lenders will feel more confident lending to borrowers with a solid, steady income.
  • Debt-to-income ratio. A key metric that can predict your ability to pay back a loan is your debt-to-income ratio, which shows how much debt you carry in relation to your income. Lenders look for a ratio of 50% or lower, since that makes it more likely you’ll be in a good position to pay back your loans.

Some lenders also will ask for a phone consultation or in-person meeting after your initial application, though some online lenders will do the entire process digitally. Speaking to someone is useful for getting your questions answered and making sure you understand all the technicalities of the application and repayment process.

The amount of time it will take to get a loan offer varies across institutions. Banks typically take longer than online lenders, which can sometimes get you an offer within a day of your application and provide funds within a few days.

Conclusion

Personal loans are an extremely useful tool in certain circumstances, such as consolidating debt, financing big and necessary expenses and getting through an emergency situation. But it is important not to mistake personal loans for “free money” and underestimate the pressure you will find yourself under when the bills are due.

Take on personal loans with great hesitation, but once you’re sure it’s the right decision, shop assertively for your best terms.

Get multiple custom offers at once

Forget filling out tons of forms. Finding your best personal loan rate is now easier than ever.

Disclaimer: Student Loan Hero is a subsidiary of LendingTree.
See how this worksNMLS #1136: Terms & Conditions Apply

Interested in a personal loan?

LendingTree allows you to compare rates from multiple lenders by filling out one easy form. Advertiser Disclosure

Student Loan Hero Advertiser Disclosure

Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print to help you understand what you are buying. Be sure to consult with a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time.

Advertiser Disclosure

Student Loan Hero Advertiser Disclosure

Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print to help you understand what you are buying. Be sure to consult with a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time.

RATES (APR)loan amount
5.99% – 19.16%1 $5,000 to $100,000
8.69% – 35.99% $1,000 to $50,000
7.99% – 35.97%* $1,000 to $35,000
99.00% – 199.00%2 $500 to $4,000
5.99% – 24.99%3 $5,000 to $35,000
7.99% – 29.99%4 $7,500 to $40,000
compare rates on Lendingtree now
NMLS #1136: Terms & Conditions Apply
1 Includes AutoPay discount. Important Disclosures for SoFi.

SoFi Disclosures

  1. Fixed rates from 5.99% APR to 18.82% APR (with AutoPay). SoFi rate ranges are current as of March 19, 2020 and are subject to change without notice. Not all rates and amounts available in all states. See Personal Loan eligibility details. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your creditworthiness, years of professional experience, income and other factors. See APR examples and terms. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account.
  2. To check the rates and terms you qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull.
    See Consumer Licenses.
  3. Minimum Credit Score: Not all applicants who meet SoFi’s minimum credit score requirements are approved for a personal loan. In addition to meeting SoFi’s minimum eligibility criteria, applicants must also meet other credit and underwriting requirements to qualify.
  4. If you lose your job through no fault of your own, you may apply for Unemployment Protection. SoFi will suspend your monthly SoFi loan payments and provide job placement assistance during your forbearance period. Interest will continue to accrue and will be added to your principal balance at the end of each forbearance period, to the extent permitted by applicable law. Benefits are offered in three month increments, and capped at 12 months, in aggregate, over the life of the loan. To be eligible for this assistance you must provide proof that you have applied for and are eligible for unemployment compensation, and you must actively work with our Career Advisory Group to look for new employment. If the loan is co-signed the unemployment protection applies where both the borrower and cosigner lose their job and meet conditions.
  5. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Financing Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)
2 Includes AutoPay discount. Important Disclosures for Opploans.

Opploans Disclosures

Direct Deposit required for payroll.

Opploans currently operates in these states: . *Approval may take longer if additional verification documents are requested. Not all loan requests are approved. Approval and loan terms vary based on credit determination and state law. Applications processed and approved before 7:30 p.m. ET Monday-Friday are typically funded the next business day.

  1. To qualify, a borrower must (i) be a U.S. citizen or permanent resident; (ii) reside in a state where OppLoans operates; (iii) have direct deposit; (iv) meet income requirements; (v) be 18 years of age (19 in Alabama); and, (vi) meet verification standards.
  2. NV Residents: The use of high-interest loans services should be used for short-term financial needs only and not as a long-term financial solution. Customers with credit difficulties should seek credit counseling before entering into any loan transaction.

  3. OppLoans performs no credit checks through the three major credit bureaus Experian, Equifax, or TransUnion. Applicants’ credit scores are provided by Clarity Services, Inc., a credit reporting agency.

  4. Based on customer service ratings on Google and Facebook. Testimonials reflect the individual’s opinion and may not be illustrative of all individual experiences with OppLoans. Check loan reviews.

  5.  

    Rates and terms vary by state.

3 Includes AutoPay discount. Important Disclosures for Payoff.

Payoff Disclosures

  1. All loans are subject to credit review and approval. Your actual rate depends upon credit score, loan amount, loan term, credit usage and history. Currently loans are not offered in: MA, MS, NE, NV, OH, and WV.
4 Important Disclosures for FreedomPlus.

FreedomPlus Disclosures

  1. The loan terms presented are not guaranteed and APRs presented are estimates only. To obtain a loan you must submit additional information and documentation and all loans are subject to credit review and our approval process. The range of APRs is 7.99% to 29.99% and your actual APR will depend upon factors including your credit score, usage and history, the requested loan amount, the stated loan purpose, and the term of the requested loan. To qualify for a 7.99% APR loan, a borrower will need excellent credit on a loan for an amount less than $12,000.00, and with a term equal to 24 months. Adding a co-borrower with sufficient income; using at least eighty-five percent (85%) of the loan proceeds to directly pay off qualifying existing debt; or showing proof of sufficient retirement savings, could help you also qualify for the lowest rate available. All loans are made by Cross River Bank and MetaBank®, N.A., Members FDIC.
* Important Disclosures for Upgrade Bank.

Upgrade Bank Disclosures

Personal loans made through Upgrade feature APRs of 7.99%-35.97%. All personal loans have a 2.9% to 8% origination fee, which is deducted from the loan proceeds. Lowest rates require Autopay and paying off a portion of existing debt directly. For example, if you receive a $10,000 loan with a 36-month term and a 17.98% APR (which includes a 14.32% yearly interest rate and a 5% one-time origination fee), you would receive $9,500 in your account and would have a required monthly payment of $343.33. Over the life of the loan, your payments would total $12,359.97. The APR on your loan may be higher or lower and your loan offers may not have multiple term lengths available. Actual rate depends on credit score, credit usage history, loan term, and other factors. Late payments or subsequent charges and fees may increase the cost of your fixed rate loan. There is no fee or penalty for repaying a loan early. Accept your loan offer and your funds will be sent to your bank or designated account within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes the transaction. From the time of approval, funds should be available within four (4) business days. Funds sent directly to pay off your creditors may take up to 2 weeks to clear, depending on the creditor. Personal loans issued by Upgrade’s lending partners. Information on Upgrade’s lending partners can be found at https://www.upgrade.com/lending-partners/.