What Are Personal Loans and How They Work
You may need money to pay for car repairs, a medical bill, or for a planned purchase. Personal loans can help pay for a single expense and you then pay it off over time. This guide will detail what a personal loan is, how it works and what to consider so you can make an informed decision.
For a quick overview of amounts, terms, and typical costs, see how personal loans work.
What Is a Personal Loan?
A personal loan is money you receive in one lump sum. You will pay it back with equal monthly payments over a set time called the term. Most personal loans are unsecured loans. This means you are not putting down a car or a house as collateral. The terms you receive may vary by your overall credit profile and earnings.
Why People Use Personal Loans
People use personal loans for lots of reasons. Some examples may include car repairs, medical bills, moving costs and planned purchases. These are just examples, not advice. Think about your budget and goals before you borrow.
How a Personal Loan Is Built
Loan Amount
This is how much you’re borrowing. Pick an amount that you can afford. Only borrow what you will pay back so that your payments are manageable.
Term
The term is how long you have to repay, usually in months or years. A shorter term means a higher payment and less overall interest. A longer term can lower the payment but will increase the total cost.
Interest and APR
Interest is the price you pay for borrowing. APR is a bigger picture measure that may also factor in some fees, in addition to interest. Use APR for simple comparisons across different loan offers.
Fees
Some loans may have an origination fee, or late fee, etc. Not every loan has the same fees. Please read the agreement so you know the overall cost.
Monthly Payment
You pay the same amount each month, until the loan is paid back. Each payment usually has a piece of principal and a piece of interest. A fixed payment can make planning easier.
From Request to Funding: The High-Level Steps
You fill out a simple form with your name, address, and identity information. You may also include income/employment information. A few lenders review your banking information.
Review and Decision
The lender reviews your information and may check your credit report. You’ll receive a decision after the review is complete. The timing varies for decision.
Funds Sent if Approved
If you accept the terms, then money would be sent to your bank account. Use the money as intended and keep your receipts and agreement together.
Repayment Basics
Due Date and Autopay
Your payment is due the same day each month. Autopay will help you pay on time. You can also set phone reminders or calendar notifications.
Late Payments
If you miss a payment, you may incur a late fee. Also, missing payments can hurt your credit. A payment more than 30 days late may be reported to the credit bureaus. Make sure to contact the lender if you think you will be late, then ask about options.
Quick Cost Example
Here is a simple example to explain how term and rate change cost.
- If you borrow $5,000 at 12 percent APR for 24 months, your payment is roughly $235, and the total you pay over two years is about $5,640.
- If the same $5,000 was paid back over 48 months at the same APR, the payment drops to about $132, but the total you pay increases to about $6,336.
This shows why it helps to look at both the payment and total cost.
Smart Money Borrowing Strategies
Always read through the complete agreement before signing anything. Pay attention to the interest charges, additional costs, and the payment due dates. Don’t just focus on the monthly payment; understand the total cost of what you are borrowing. Only borrow what you know you can reasonably repay in full within your current cash flow.
Make all your payments on time every month! If you cannot make a payment, reach out to the lender early. Many times, a simple conversation can help you avoid late fees or other issues.
Summary
A personal loan gives you a fixed amount of money that you will pay back with a predictable payment schedule. You will be making consistent monthly payments for a set period. Understanding the money to borrow, when repayment begins, loan interest rate, any fees, and the process to apply to get your money will correctly position to consider if getting a personal loan is right for your personal needs and finances.