- Personal Loans: What to Know Before You Apply
- What is a Personal Loan?
- How to Apply for a Personal Loan
- Minimize the Impact of Inquiries
- Pros and Cons of Personal Loans
- Personal Loans and Your Credit
- How to Get a Personal Loan
- 2. Compare estimated rates
- 3. Get pre-qualified for a loan
- 4. Shop around for personal loans
- The Pros And Cons Of Personal Loans
- What is a personal loan and how does it work?
- Pros and cons of a personal loan
- Key benefits of personal loans
- Flexibility and versatility
- No collateral requirement
- Easier to manage
- Key drawbacks of personal loans
- Interest rates can be higher than alternatives
- Fees and penalties can be high
- Higher payments than credit cards
- Can increase debt
- Is a personal loan right for you?
- Final considerations
- Learn more:
Personal Loans: What to Know Before You Apply
Credit comes in many forms, including credit cards, mortgages, automobile loans, purchase financing over time and personal loans. Each type of credit serves a certain purpose for a goal you may have, whether it's to buy a house or car, or to allow you to break up a big expense into more manageable monthly payments.
A personal loan is a form of credit that can help you make a big purchase or consolidate high-interest debts. Because personal loans typically have lower interest rates than credit cards, they can be used to consolidate multiple credit card debts into a single, lower-cost monthly payment.
Credit can be a powerful financial tool, but taking out any type of loan is a serious responsibility. Before you decide to apply for a personal loan, it's important to carefully consider the advantages and disadvantages that can affect your unique credit picture.
What is a Personal Loan?
When you apply for a personal loan, you ask to borrow a specific amount of money from a lending institution a bank or credit union.
While funds from a mortgage must be used to pay for a house and you'd get an auto loan to finance a car purchase, a personal loan can be used for a variety of purposes.
You may seek a personal loan to help pay education or medical expenses, to purchase a major household item such as a new furnace or appliance, or to consolidate debt.
Repaying a personal loan is different from repaying credit card debt. With a personal loan, you pay fixed-amount installments over a set period of time until the debt is completely repaid.
Before you apply for a personal loan, you should know some common loan terms, including:
- Principal — This is the amount you borrow. For example, if you apply for a personal loan of $10,000, that amount is the principal. When the lender calculates the interest they'll charge you, they base their calculation on the principal you owe. As you continue to repay a personal loan, the principal amount decreases.
- Interest — When you take out a personal loan, you agree to repay your debt with interest, which is essentially the lender's “charge” for allowing you to use their money, and repay it over time. You'll pay a monthly interest charge in addition to the portion of your payment that goes toward reducing the principal. Interest is usually expressed as a percentage rate.
- APR — APR stands for “annual percentage rate.” When you take out any kind of loan, in addition to the interest, the lender will typically charge fees for making the loan. APR incorporates both your interest rate and any lender fees to give you a better picture of the actual cost of your loan. Comparing APRs is a good way to compare the affordability and value of different personal loans.
- Term — The number of months you have to repay the loan is called the term. When a lender approves your personal loan application, they'll inform you of the interest rate and term they're offering.
- Monthly payment — Every month during the term, you'll owe a monthly payment to the lender. This payment will include money toward paying down the principal of the amount you owe, as well as a portion of the total interest you'll owe over the life of the loan.
- Unsecured loan — Personal loans are often unsecured loans, meaning you don't have to put up collateral for them. With a home or auto loan, the real property you're buying serves as collateral to the lender. A personal loan is typically only backed by the good credit standing of the borrower or cosigner. However, some lenders offer secured personal loans, which will require collateral, and could provide better rates than an unsecured loan.
How to Apply for a Personal Loan
Whenever you ask a lender for any kind of credit, you'll have to go through the application process.
However, before you submit a personal loan application, it's important to review your credit report and your credit score, so you'll understand what lenders might see when they pull your credit report and scores.
Remember, checking your own credit report never affects your credit scores, so you can check as often as you need.
Once you've reviewed your credit and taken any necessary steps what you see, you can apply for a personal loan through any financial institution such as a bank, credit union or online lender. Every lender you apply to will check your credit report and scores.
Lenders will usually consider your credit scores when reviewing your application, and a higher score generally qualifies you for better interest rates and loan terms on any loans you seek. The lender will also ly look at your debt-to-income ratio (DTI), a number that compares the total amount you owe every month with the total amount you earn.
To find your DTI, tally up your recurring monthly debt (including credit cards, mortgage, auto loan, student loan, etc.), and divide by your total gross monthly income (what you earn before taxes, withholdings and expenses). You'll get a decimal result that you convert into a percentage to arrive at your DTI.
Lenders to see DTIs under 36%, but many may provide loans to borrowers with higher ratios.
Minimize the Impact of Inquiries
When you apply for credit and a lender reviews your credit report, a hard inquiry is noted on your report. Hard inquiries remain on credit reports for two years, and their impact diminishes over time. However, in the short term, too many hard inquiries on your report can have a negative effect on your credit score.
If you'll be comparison shopping by applying to more than one lender, be sure to do so in a short time frame to minimize the impact of hard inquiries.
Generally, credit scoring models will count multiple hard inquiries for the same type of credit product as a single event as long as they occur in a short window of a few weeks.
Don't stretch your comparison shopping and applications over a period of months.
Another option is to ask if a lender can prescreen or preapprove you for a loan offer. Preapproval often counts as a soft inquiry, which doesn't affect credit scoring.
Pros and Cons of Personal Loans
any other type of credit, a personal loan has advantages and disadvantages, depending on your specific financial situation. Whether a loan is good for you will largely depend on how wisely you're managing your borrowing over time.
On the plus side, a personal loan can help you make a big purchase. Breaking a large expense into smaller payments over time can help make that cost more manageable when you have stable income.
Personal loans typically have interest rates that are lower than what you would pay for a credit card purchase.
A personal loan can also be a good way to consolidate multiple high-interest credit card debts into a single, lower-interest payment.
When you take out a personal loan and make on-time payments, you're helping to build a positive credit history for yourself, which contributes positively to many credit scoring calculations. Your responsible use of credit can positively impact many factors that credit scoring considers, including payment history, credit utilization ratio, and mix of credit types.
However, if you pay late or miss a payment altogether, that can negatively affect your credit. Late or missed payments can lower credit scores, and a lower credit score can limit your ability to get credit at better rates.
If you fall far behind on making loan payments, your personal loan may go into collections or be charged off — and both negative events appear on your credit reports and can also lower your credit scores.
Ultimately, if a personal loan makes it harder for you to pay all your bills on time, you may want to consider other options.
While not ideal, bankruptcy might be something to look into, but know it can appear on your credit report and negatively affect your credit for seven to ten years.
Personal Loans and Your Credit
It's important to manage any type of credit you use wisely, including a personal loan. Personal loans can be helpful when managed well, but taking on debt should never be something you do lightly – or without looking carefully at your overall financial picture before you pull the trigger.
Before you make any kind of important credit decision, it's best to check your credit report so you understand your current credit standing. Plus, reviewing your report can help you better understand how your decision may affect your credit in the future.
How to Get a Personal Loan
If you need to borrow money to consolidate credit card debt, move cross-country or even finance an adoption, a personal loan can help cover your expenses without breaking the bank.
Most personal loans are unsecured loans, meaning they don’t require collateral such as a house or car. Loan amounts range from $1,000 to more than $50,000 and are paid back in fixed payments, typically over two to five years. Rates and terms will vary your credit.
» See our picks: Best personal loans
A strong credit score gives you a better chance of qualifying for a personal loan and getting a lower interest rate. Assess your creditworthiness by checking your free credit score. In general, scores fall into the following categories:
- 720 and higher: Excellent credit
- 630-689: Fair or average credit
Looking at a less than friendly score? Take steps to build it up before you apply. The biggest factors affecting your credit score are on-time payments and the amount of credit you use relative to credit limits. And make a stink if you have to — you can request your free credit report and dispute any errors it may contain.
» Know your options: What credit score do I need for a personal loan?
2. Compare estimated rates
Knowing your credit score will give you a better idea of the interest rate and payment amounts you might receive on a personal loan. Use the calculator below to see estimates.
3. Get pre-qualified for a loan
Pre-qualifying for a loan gives you a sneak peak at the kind of offers you may receive. Many online lenders perform a soft credit check during pre-qualification that doesn’t affect your credit score, so checking it out ahead of time is a win-win.
- Monthly debt obligations (rent, student loans, etc.).
- Employer’s name, work address and phone number.
- Address, email, phone number.
You may not pre-qualify for a loan. Besides a low credit score, reasons for being denied include:
- Little or no work history.
- A high debt-to-income ratio; above 40% may be considered risky.
- Too many recent credit inquiries, such as credit card applications.
» See your offers: Pre-qualify on NerdWallet
4. Shop around for personal loans
Unsecured loans are offered at online lenders, banks and credit unions. Compare your pre-qualified offers with loan amounts, monthly payments and interest rates from other types of lenders to get the best loan offer.
Credit unions may offer lower interest rates and more flexible terms, especially to borrowers with bad credit. They’re also your best shot for a small loan — $2,500 or less.
Few big financial institutions offer unsecured personal loans; Citibank, Discover and Wells Fargo are some that do. A local community bank may have better rates, especially if you have an existing relationship.
» Shop around: Top banks that offer personal loans
Before you choose a personal loan:
See if you qualify for a 0% credit card. If you have good credit, you can probably get a credit card that has 0% interest on purchases for a year or longer. If you can repay the loan in that time, a credit card is your cheapest option.
Consider a secured loan. If your credit isn’t great, you may get a better interest rate with a secured loan. You will need collateral, such as a car or savings account. If you own a house, a home equity loan or line of credit can be significantly cheaper than an unsecured loan.
Add a co-signer. A co-signed personal loan may be an option for borrowers who don’t qualify for a loan on their own. The lender considers the credit history and income of both the borrower and co-signer in approving a loan and may offer more favorable terms.
» If your credit is lacking: Best personal loans for fair credit
As with any financing, read the terms of the loan offers and get answers to your questions. In particular, watch for:
Prepayment penalties. Most online lenders do not charge a fee for paying off the loan early, called a prepayment penalty or exit fee.
Automatic withdrawals. If a lender requires payments be automatically withdrawn from your checking account, consider setting up a low balance alert with your bank to avoid overdraft fees.
APR surprises. The total cost of your loan, including any origination fees, should be clearly disclosed and figured into the annual percentage rate.
In addition, look for these consumer-friendly features:
Payments are reported to credit bureaus. Your credit score benefits if the lender reports on-time payments to credit reporting agencies. All lenders reviewed by NerdWallet do so.
Flexible payment features. Some lenders let you choose your payment due date, forgive an occasional late fee or allow you to skip a payment in case of hardship.
Direct payment to creditors. Some lenders will send borrowed funds directly to creditors, which is especially beneficial for borrowers who are consolidating debt.
» Red flags: Learn the warning signs of predatory lending
Once you’ve selected a lender that matches your needs, you’ll need to provide the following documents to formally apply for the loan:
- Identification: passport, driver’s license, state ID or Social Security card
- Verification of address: utility bills or copy of lease
- Proof of income: W-2 forms, pay stubs, bank statements or tax returns
The lender will run a hard credit check that may briefly knock a few points off your credit scores. Upon final approval, you’ll receive your funds according to the lender’s terms, typically within a week.
Taking out a personal loan can help you relieve your debt load and cover unexpected costs, but take stock of your options before settling on one choice. Find the lowest rates, borrow only what you need and be prompt with your repayments.
» Plan for payoff: How to manage your personal loan payments
The Pros And Cons Of Personal Loans
If you need extra cash to pay for home improvements, finance a wedding or consolidate high-interest debt, you might want to consider a personal loan. Used wisely, an unsecured personal loan can fill a void in your budget without risking your home or other assets.
As with other loans, rates for personal loans hinge on your credit score, income and debt-to-income ratio, and they’re not the right choice for everyone. Consider these pros and cons of personal loans before you make a decision.
What is a personal loan and how does it work?
A personal loan is a type of installment loan that gives you a fixed amount of money, often anywhere from $1,000 to $50,000, in one lump sum. Personal loans are usually unsecured, meaning you don’t have to use collateral to secure funds.
Repayment terms can range between one and 10 years. Personal loans can be used for almost anything, although specific lenders may impose restrictions on their use.
Interest rates on personal loans are fixed, so your interest rate will not change while you repay your loan.
Applying for a personal loan is similar to applying for a credit card. You’ll need to enter your personal information, your financial information and the details about your desired loan.
Before approving you, the lender will run a hard credit check, which may temporarily lower your credit score.
If your financial picture and credit score are sufficient for the lender — often, you need a credit score in the mid-600s — the lender will set your interest rate, loan amount and terms. You can sign up for a Bankrate account to get prequalified for a personal loan in under 2 minutes.
You’ll receive personal loan funds all at once and begin paying them back immediately. Your payment will be the same amount every month until your loan is paid off: a portion of your principal, plus interest charges.
Pros and cons of a personal loan
There are both advantages and disadvantages to choosing a personal loan over another financing option. Here are some factors to consider when making your decision.
Key benefits of personal loans
Personal loans can offer benefits over other types of loans. Below are a few advantages of using this type of financing over other options.
Flexibility and versatility
Some types of loans can only be used for a certain purpose. For example, if you take out a car loan, the only way to use the funds is to purchase a vehicle. Personal loans can be used for many purposes, from consolidating debt to paying off medical bills.
If you want to finance a major purchase but don’t want to be locked into how you use the money, a personal loan can be a good alternative. Check with your lender on the approved uses for the loan before applying.
Personal loans often come with lower interest rates than credit cards. As of February 2021, the average personal loan rate was 11.84 percent, while the average credit card rate was 16.04 percent.
Consumers with excellent credit history can qualify for personal loan rates in the range of 6 percent to 8 percent. You may also qualify for a higher loan amount than the limit on your credit cards.
No collateral requirement
Unsecured personal loans don’t require collateral for you to get approved. This means you don’t have to put your car, home or other asset up as a guarantee that you’ll repay the funds.
If you’re unable to repay the loan the agreed-upon terms with your lender, you’ll face significant financial consequences.
However, you don’t have to worry about losing a home or a car as a direct result.
Easier to manage
One reason some people take out personal loans is to consolidate debt, such as multiple credit card accounts. A personal loan with a single, fixed-rate monthly payment is easier to manage than several credit cards with different interest rates, payment due dates and other variables.
Borrowers who qualify for a personal loan with a lower interest rate than their credit cards can streamline their monthly payments and save money in the process.
Key drawbacks of personal loans
Personal loans can be a good option for some, but they are not the right choice in all situations. Here are a few negatives to consider before taking out a personal loan.
Interest rates can be higher than alternatives
Interest rates for personal loans are not always the lowest option. This is especially true for borrowers with poor credit, who might pay higher interest rates than with credit cards.
If you have sufficient equity in your home, you can borrow against it using a home equity loan or a home equity line of credit (HELOC). A home equity loan is an installment loan, while a HELOC works similarly to a credit card. One downside to having a home equity loan or a HELOC is that your home is used as collateral. If you default on the loan, you risk losing your home to foreclosure.
Credit card balance transfer offers are another alternative to personal loans. You can save money with a good balance transfer offer, provided you pay the balance off before the special offer period ends. Our credit card balance transfer calculator will help you see how long it will take to pay off your balance.
Fees and penalties can be high
Personal loans may come with fees and penalties that can drive up the cost of borrowing. Some loans come with origination fees of 1 percent to 6 percent of the loan amount. The fees, which cover loan processing, can either be rolled into the loan or subtracted from the amount disbursed to the borrower.
Some lenders charge prepayment penalties if you pay the balance off before the end of your loan term. Before applying, review all fees and penalties of any personal loans you are considering.
Higher payments than credit cards
Credit cards come with small minimum monthly payments and no deadline for paying your balance off in full. Personal loans require a higher fixed monthly payment and have to be paid off by the end of the loan term.
If you consolidate credit card debt into a personal loan, you’ll have to adjust to the higher payments and the loan payoff timeline or risk defaulting.
Can increase debt
Personal loans can be a tool for consolidating debt such as credit card balances, but they do not address the cause of the debt. When you pay your credit cards off with a personal loan, it frees up your available credit limit. For overspenders, this offers an opportunity to rack up more charges rather than free themselves from debt.
Is a personal loan right for you?
Personal loans are an attractive option if you need quick cash; with many lenders, especially those that operate online, funds can be made available in a matter of days.
Interest rates can also be low, particularly if you have good credit, making personal loans a good way to consolidate and pay off credit card debt.
Other good reasons to use personal loans include paying for emergency expenses or remodeling your home.
However, personal loans are not a good idea for everyone. After all, personal loans are still a form of debt. If you know that you have a habit of overspending, for instance, paying your credit cards off with a personal loan may not make sense if you’ll immediately begin building up a new credit card balance.
You’ll also want to consider a personal loan’s repayment timeline and monthly payments.
Before accepting a personal loan, use a personal loan calculator to determine whether or not you can afford the monthly payments for the term you’ll spend paying it off.
In some cases, it may make more sense to build up your savings to pay for a large purchase instead of taking out a personal loan and making payments with interest for many years.
Before taking out a personal loan, make a plan for how you’ll use the funds and how you’ll repay them (with interest).
Weigh the pros and cons of taking out a personal loan rather than using another financing option. Review alternatives such as a home equity loan, a HELOC or a credit card balance transfer.
Use a Bankrate calculator to help you determine the best borrowing option for you.
If you’re considering a personal loan, get quotes from several lenders to compare interest rates and loan terms. Don’t forget to read the fine print, including fees and penalties. Once you have all the data, decide if the benefits of a personal loan outweigh the drawbacks before making a commitment.