Personal Loan: What It Is, How It Works, and How to Get One

If you need money for an emergency, a big purchase, or to consolidate debt, a personal loan might be a good option. But what exactly is a personal loan? How does it work? And how can you get one?

In this guide, we’ll explain everything you need to know about personal loans in simple, easy-to-understand language.

What Is a Personal Loan?

A personal loan is money you borrow from a bank, credit union, or online lender that you pay back in fixed monthly payments over time. Unlike a mortgage (for a house) or an auto loan (for a car), a personal loan can be used for almost anything—medical bills, home repairs, vacations, weddings, or even debt consolidation.

Key Features of a Personal Loan:

Fixed Amount: You borrow a set amount (e.g., $5, 000 or$ 10,000).
Fixed Interest Rate: The interest rate usually stays the same for the entire loan term.
Fixed Repayment Term: You repay the loan over a set period (usually 1 to 7 years).
Unsecured (Mostly): Most personal loans don’t require collateral (like a house or car).

How Does a Personal Loan Work?

You Apply for the Loan
- You fill out an application with a lender (bank, credit union, or online lender).
- The lender checks your credit score, income, and debt-to-income ratio.
The Lender Approves (or Denies) Your Application
- If approved, you’ll get an offer with the loan amount, interest rate, and repayment terms.
- You can accept or decline the offer.
You Receive the Money
- Once accepted, the lender deposits the money into your bank account (usually within a few days).
You Repay the Loan in Monthly Installments
- Each month, you pay back a portion of the loan plus interest.
- Payments stay the same (fixed) throughout the loan term.
The Loan Is Paid Off
- After the last payment, the loan is closed, and you owe nothing more.

Types of Personal Loans

Not all personal loans are the same. Here are the main types:

1. Secured Personal Loans

Requires collateral (like a car, savings account, or home).
Lower interest rates (because the lender has less risk).
Example: A loan using your car as security.

2. Unsecured Personal Loans

No collateral needed.
Higher interest rates (riskier for lenders).
Approval depends on credit score and income.

3. Debt Consolidation Loans

Used to combine multiple debts (like credit cards) into one loan.
Can lower interest rates and simplify payments.

4. Fixed-Rate vs. Variable-Rate Loans

Fixed-rate: Interest rate stays the same.
Variable-rate: Interest rate can change over time.

Pros and Cons of Personal Loans

✅ Pros

✔ Fast Funding: Get money quickly (sometimes within 24 hours).
✔ No Collateral Needed (for unsecured loans).
✔ Fixed Payments: Easy to budget since payments stay the same.
✔ Lower Interest Than Credit Cards (if you have good credit).

❌ Cons

✖ Interest Rates Can Be High (especially with bad credit).
✖ Fees May Apply (origination fees, late fees, prepayment penalties).
✖ Risk of Debt Cycle (borrowing more than you can repay).

How to Get a Personal Loan

Step 1: Check Your Credit Score

Lenders prefer good credit (670+) for lower interest rates.
If your score is low (below 580), work on improving it first.

Step 2: Compare Lenders

Banks, credit unions, and online lenders offer personal loans.
Compare interest rates, fees, and repayment terms.

Step 3: Prequalify (If Possible)

Many lenders let you check rates without hurting your credit.
Prequalification gives an estimate of loan terms.

Step 4: Apply for the Loan

Submit documents like pay stubs, bank statements, and ID.
The lender will do a hard credit check, which may slightly lower your score.

Step 5: Accept the Loan & Receive Funds

If approved, review the loan terms carefully.
Sign the agreement, and the lender will deposit the money.

Step 6: Repay on Time

Set up autopay to avoid missed payments.
Paying early can save on interest (if no prepayment penalty).

Where to Get a Personal Loan?

Banks (Chase, Wells Fargo, Bank of America) – Good for existing customers.
Credit Unions – Lower rates for members.
Online Lenders (SoFi, Upstart, LendingClub) – Fast approval, good for fair credit.
Peer-to-Peer (P2P) Lenders (Prosper, Peerform) – Borrow from individuals.

What If You’re Denied a Personal Loan?

If you get rejected:

Ask why (lenders must explain).
Improve your credit score before reapplying.
Apply with a co-signer (someone with good credit who guarantees the loan).
Try a secured loan (if you have collateral).

Final Thoughts

A personal loan can be a helpful financial tool if used wisely. It’s great for emergencies, big expenses, or consolidating high-interest debt. However, always borrow only what you need and compare lenders to get the best deal.

Before taking a loan, ask yourself:

Can I afford the monthly payments?
Is this the cheapest way to borrow?
Do I really need this loan, or can I save up instead?

If you’re responsible with repayment, a personal loan can be a smart financial move!

Need Help Choosing a Loan?

Check out loan comparison websites like NerdWallet, Bankrate, or Credit Karma to find the best rates for your situation.