A personal loan is an installment loan that provides a lump sum of money, which you repay with interest over a fixed period. Unlike other loans, such as mortgages, personal loans can be used for almost any purpose, from consolidating high-interest debt to paying for home renovations or other large purchases.
How personal loans work
The personal loan process generally follows these steps:
- Application: You apply to a lender, which can be a bank, credit union, or online lender.
- Lender review: The lender reviews your application based on your credit history, income, and overall creditworthiness.
- Offer: If approved, the lender presents you with a loan offer that details the loan amount, interest rate (APR), and repayment terms.
- Acceptance and funding: You accept the offer, and the funds are typically deposited into your bank account in a lump sum. Some lenders can send the money directly to your creditors if you are using the loan for debt consolidation.
- Repayment: You repay the loan in fixed monthly installments over the set term, which can range from one to seven years.
Types of personal loans
Unsecured personal loans
- Collateral: Do not require collateral, such as a car or home.
- Approval: Because they are not backed by collateral, approval is based primarily on your creditworthiness and income.
- Risk and rates: They pose a higher risk to lenders and may have higher interest rates compared to secured loans.
Secured personal loans
- Collateral: Require you to provide an asset as collateral. If you fail to repay, the lender can seize the collateral.
- Rates: Because the lender’s risk is lower, secured loans often have lower interest rates.
- Usage: They are less common than unsecured personal loans for general purposes.