A personal loan is a general purpose installment loan that borrowers most frequently use to consolidate existing debt or make large one-time purchases. If you’re thinking about taking out a personal loan, we’ve broken down the common terms and features of them and how to qualify for one.
- How Do Personal Loans Work?
- What Can You Use a Personal Loan For?
- How to Qualify for a Personal Loan
How Do Personal Loans Work?
A personal loan is a general purpose installment loan that an individual can take out from a bank, credit union or other type of lender. When you take out a personal loan, you will apply for a specific amount of money, and if approved, receive this amount as a lump sum. You will then be required to pay back this amount plus interest in installments over a set period of time.
In general, personal loans are unsecured loans, which means that you do not need to put up collateral, such as your car or house, to receive funds. Most personal loans also come with fixed interest rates and repayment periods. This means that, unlike a credit card, you’ll need to repay your personal loan with a fixed period of time, typically a few years. In the table below, we look at the average amounts and terms associated with a personal loan.
|Loan Amount||$1,000 - $40,000|
|Interest Rates||5% - 36%|
|Loan Terms||1 - 7 years|
Most personal loans are also fully amortized. Amortized loans have the same monthly payment, with a portion of each payment going towards both the principal loan amount and interest. Amortized loans are easier to budget for as there are no balloon payments at the end of the loan term as there are with unamortized loans.
What Can You Use a Personal Loan For?
Because personal loans are general purpose loans, they can be used for a multitude of reasons. One of the most common reasons individuals use personal loans is to consolidate existing debt. Using a personal loan to consolidate debt can streamline managing your debt as you’ll only need to make one monthly payment as opposed to multiple. It can also reduce the amount you pay in interest if the personal loan has a lower interest rate than the other debts.
Other commons reasons that individuals take out personal loans include paying for large one-time expenses, such as home improvement projects, vacations, weddings, honeymoons, medical expenses or relocation. Many personal loans can also be used to start or expand a business, making them a reasonable option if you can’t get a traditional business loan. Finally, some lenders may allow you to use a personal loan for educational expenses, such as postsecondary education or continuing education (e.g., bootcamps).
How to Qualify for a Personal Loan
Qualifying for a personal loan is primarily based on your credit score. If you have good to excellent credit (any FICO score from 690 to 850), you may be better off getting a good balance transfer or introductory 0% APR credit card than a personal loan. For those with credit scores under 690, a personal loan will likely be easier to qualify for than an introductory 0% APR credit card.
Every lender will have different credit requirements. However, banks will typically require borrowers to have credit scores of at least 680 to qualify. Many online lenders will have more lenient credit requirements, with some requiring only a minimum credit score of 580 to apply. Credit unions are another good source for a personal loan if your credit score is less than perfect. Many credit unions are willing to work with borrowers who have poor or limited credit history.
Lenders may also consider other factors when evaluating your application, such as your income, educational and work history and existing debt. For income and debt requirements, lenders will usually want to see proof that you have a steady and stable income (and sometimes a minimum income) as well as a reasonable debt-to-income ratio, which is anything under 40% to 45%. More lenders are also now considering educational and work history when evaluating potential borrowers to get a more holistic picture. This can be good news for borrowers with limited or no credit history as good educational or employment history can supplement a lack of credit history.