How Do Personal Loans Work?

Personal loans are a versatile tool for anyone seeking financial flexibility. Whether you’re consolidating debt, covering unexpected expenses, or financing major purchases, understanding how personal loans work and what's required to apply for one is essential knowledge for any borrower.

When weighing your loan options, it’s important to understand how this loan option works, how to qualify for one, and the most common things this loan option is used for. 

What is a Personal Loan?

They are a type of loan that can be used for various personal expenses and is usually based on creditworthiness and income. This is a flexible loan option for borrowers who need a quick and simple money option for important personal expenses. 

How Do Personal Loans Work?

Before you can decide if this is the right loan for you, you need to know how the personal loan application process works. These loans work very simply with 3 essential steps. 

First you’ll fill out an application, then you’ll receive your money if you get approved, and lastly you’ll make several payments over time to eventually repay what you borrowed.

Step 1: Fill out an application

Your first step is to fill out a personal loan application with a reputable lender you trust. This application might require some personal information like your contact information, income, and possibly credit history. This information helps lenders decide whether your application should be approved or not.

Step 2: If approved, get money

Next, the lender will review your application and decide whether you’re approved for a loan or not. If approved, you’ll receive a loan agreement to sign and get your funds. You might be able to receive cash or get your money deposited into your bank account.

Step 3: Make several payments over time

Unlike a payday loan where you repay the loan in one lump sum on your next pay date, this loan is repaid in multiple payments over time. Depending on your lender and loan terms, you might need to make payments over a few months or a few years.

How to Get a Personal Loan

Exactly how to qualify for a personal loan will depend on the lender you choose and the criteria they are looking for in a borrower. 

Be ready to potentially provide information like your contact information, government identification, how much you make in income, your recent paystubs, your payment history with other forms of credit, or even your debt-to-income ratio.

With this information, lenders want to make sure borrowers are able to make loan payments without breaking the bank. Take a look at your income, debt-to-income ratio, and your monthly budget to check if you can comfortably fit a loan payment into your finances right now.

Before you get a loan, there are a few other questions you might want answered like: 

Do they require collateral? Unsecured personal loans are the most common for this type of loan. Loans are unsecured when they don’t require collateral, meaning they don’t require you to put up an asset (like the title of your car) to get the loan. So, in general, this loan doesn’t require collateral.

Do they have a fixed interest rate? Whether a loan has a fixed rate or not will depend on the individual lender and loan you choose to go with. Read your loan agreement carefully to see if there are any extra fees or rate changes with your loan.

Do they impact your credit score? Whether a loan impacts your credit score in a negative way depends a lot on whether you make on-time payments or not. By paying off your loan on time, you can avoid taking a hit to your credit score. Before getting any type of credit, it’s also a good idea to do some budgeting calculations or find a personal loan calculator, to make sure you can afford these monthly loan payments. That way, you’ll rest assured knowing you won’t be late making payments.

How much money can you get? How much you can borrow can depend on several factors like the lender and what kind of loan amounts they offer. Lenders may also consider factors like your income, credit, and existing debt in determining how much you’ll be able to borrow. It really comes down to the lender and your individual financial situation.

How does interest work on a personal loan? Personal loan interest rates work just like any other type of loan. A personal loan rate is applied to the loan amount and is included in your repayments. So each repayment helps pay back the principal amount you borrowed and the interest costs of borrowing the loan.

How do I find the best personal loans? Whether you need a large or small personal loan, you’ll find the best options by shopping for the best personal loan rates from a reputable lender with great customer reviews. You’ll want to compare costs between different options, but don’t forget to also compare customer reviews to make sure you’re choosing a licensed lender you can put your trust in.

Reasons to Use a Personal Loan

There are many reasons people use this type of loan. They can be a helpful financial option when you need some flexibility added to your wallet for an important expense.

Some of the common reasons to use a personal loan include consolidating debts, refinancing an existing loan, paying for unexpected or emergency expenses, making home renovations, fixes, or improvements, financing big life events, or making an investment in a business venture.

Debt Consolidation

One of the main reasons individuals turn to this loan is to consolidate existing debts. By combining multiple high-interest debts into a single loan with a potentially lower interest rate, borrowers can simplify their debt repayments and potentially save money on interest over time.

Refinancing an Existing Loan

This type of loan can also be used to refinance existing loans, such as auto loans or credit card balances. By refinancing at a lower interest rate or extending the repayment term, borrowers may reduce their monthly payments and overall interest costs.

Emergency Expenses

When unexpected expenses arise, such as medical bills or car repairs, this type of loan can provide quick access to funds. Unlike traditional loans, these loans often have faster approval times, making them a viable option for covering urgent financial needs.

Home Improvement Projects

Whether you’re renovating a kitchen, upgrading a bathroom, or making structural repairs, home improvement projects can be costly. They offer a flexible financing solution for homeowners looking to invest in their property without tapping into home equity or using high-interest credit cards.

Financing Big Life Events

From weddings to vacations, major life events often come with significant expenses. These loans can help individuals finance life milestones, providing the funds needed to celebrate special occasions or achieve long-held aspirations.

Business Investments

Entrepreneurs and small business owners may use this type of loan to fund startup costs, expand business operations, or invest in new equipment. With fewer restrictions compared to business loans, these loans offer flexibility and accessibility for those looking to grow their small business ventures.