What is a Personal Loan?

Personal loans are a simple form of borrowing. They can be used to achieve all sorts of goals. For example, you could use them to renovate your home, go to the dentist, or get rid of debt.

It’s simple: you borrow a lump-sum from a lender or bank, and pay it back with fixed monthly installments.

Learn how personal loans are structured, which types of loans are available and what you need to do to get one.

What is the process of personal loans?

Personal loans are not “revolving credit” like credit cards. A personal loan has a start and an end.

You’ll usually have up to seven year to pay back the loan in monthly installments, at a fixed simple rate. The account will close once you have paid off the loan.

Amounts

Personal loans range in amount from $600 up to $100,000 but most are for smaller amounts.

TransUnion reports that more consumers are turning to personal loans and credit cards to cope with rising costs of living.

Forbes reported in the fourth quarter 2022 that more than 22.5 million Americans had an unsecured loan. The average amount of the loan per borrower was $11,116, which is a significant rise from previous years.

Secured and unsecured loans

You don’t have to put your house on the line like you would with home equity loan and how does it work. You don’t need to risk your home like you would if you were taking out a Home Equity Loan.

Unsecured loans pose a greater risk to lenders. Personal loans have higher rates of interest than secured loans such as mortgages or auto loans.

Interest Rates

Interest rates on personal loans can start as low at 4% or APR, but they can go up to 36%. Forbes estimates that the average personal loan interest rate in February 2023 will be between 12 and 15 percent.

Your rate is determined by your credit history, income and other factors. If you have a score that isn’t impressive, then you will likely qualify only for loans at high interest rates.

Fixed rates and variable rates

The interest rates on most personal loans are fixed, meaning that you will pay the same amount each month for the entire life of the loan.

Budgeting is easier with fixed-rate loans, because you know exactly what you owe every month.

Some lenders offer variable-rate loans where your interest rate can fluctuate over time depending on the market. These changes are often linked to a benchmark like the federal fund rate.

The interest rate on variable-rate loans might be lower at first, but it could rise if the market changes. Short-term loans are less affected by the market.

Lending Options

If you need a personal loan, you have a variety of choices. You can obtain a personal loan from a bank, credit union or online lender.

Some online lenders will consider other factors to determine your eligibility for a loan, including your income and utility bill history.

Origination fees

These fees are often called origination charges. These fees can range between 1% and 10% of the amount that you wish to borrow, depending on your score.

You may be required to pay the origination fee upfront, or it will be included in your interest rate.

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Personal loans are available in different types.

You may want to look at other personal loan options besides unsecured loans.

Secured Loans

Some lenders offer guaranteed personal loans. To get a lower interest rate, you can borrow against an asset that you own. Examples include a house, car or saving account.

Remember that a secured loan is a risk. If you don’t pay your loan back, the lender may take any assets that you have put up as security.

Debt consolidation loans

A loan for debt consolidation can help those whose debts have begun to spiral out of control.

Your new loan can be used to pay all your high-interest debts immediately. This leaves you with one monthly payment, which usually has a lower rate of interest. You can save money and get out of debt much faster.

Loans with co-signers

You might want to consider getting a cosigner if your credit is patchy, or if your financial history is non-existent. This person will be willing to pay off your debt in the event that you fail.

A loan that is co-signed by a friend or relative can be a blessing to you, but a curse to your generous volunteer. Be sure to assess your ability before asking a friend or family member to co-sign.