What Is a Personal Loan? How They Work and When to Use One
Personal loans are lump sums of money you can borrow to consolidate debt or pay for large expenses like home renovations or weddings. It also can help you out in an emergency, like when a large appliance breaks or you get a surprise medical bill.
There’s a lot that goes into a decision to get a personal loan. Even though they’re a flexible way to pay for things you don’t have the cash for outright, it’s not always the best choice.
Our guide will cover what a personal loan is, key features, pros and cons, and what you can typically use it for.
What Is a Personal Loan?
A personal loan is a lump sum of money that you get from a lender and agree to pay back over a certain period of time, typically at a fixed interest rate. That’s the simple definition, but there’s a lot of variation among personal loans.
Some people get them to consolidate debt, others to pay for large purchases like weddings or home renovations. Interest rates can be as low as 5.99% and as high as 35.99%, and the timeline to pay it back is usually anywhere from 12 to 84 months. Not only that, you can get these loans from banks, credit unions and online lenders. Most loans are unsecured, so you won’t have any collateral tied to them if you can’t pay it back. Secured personal loans do exist. However, you risk whatever collateral you used to back the loan (like your house or car) if you can’t make payments.
How Do Personal Loans Work?
Once you know how much money you need, you try to find a lender that’s willing to loan it to you at an interest rate that doesn’t make your eyes pop out of your head. Your interest rate is mostly determined by your credit score, income, how much you’re borrowing and how long the loan term is.
When you apply for the loan, it may make your credit score dip slightly because the lender will run a hard inquiry. It’s normal and temporary, but something to be aware of.
You then pay it back — with interest — in fixed monthly payments until the loan is paid off. The interest rate makes a big difference in how much you pay over the total life of the loan. For example, if you borrowed $10,000 to pay back within three years at a 12% interest rate, you’d have a monthly payment of around $332. You’d pay $1,957 in interest on top of the $10,000. If your interest rate had been 25%, your monthly payment would have been $397, and the interest charges would’ve added up to $4,313.
Key Features of a Personal Loan
Here are common terms and features of personal loans and what they mean.
- Loan amount: There are limits to how much and how little you can borrow. Most loans tend to be between $5,000 and $50,000. However, some places loan out as little as $1,000 and as much as $100,000, it’s just not as common.
- Repayment term: This is how long you have to repay the loan. This is usually between 12 and 84 months, or 1-7 years. The longer the loan term, the lower your monthly payment will be. It may mean a higher interest rate, however.
- Annual Percentage Rate: The APR reflects all costs of borrowing, not just the interest rate. So it includes other fees like origination fees and administrative costs.
- Origination fee: Lenders charge these to cover the cost of issuing the loan. It’s usually around 1%-10% of the loan amount.
- Minimum credit score: Not all lenders will require you to have a minimum credit score, but some might. If they do, it will probably be around 580-620.
- Secured vs. Unsecured: Most loans are unsecured, meaning they aren’t tied to any collateral. But there are secured loans. This is when you use an asset like a house or car to back the loan, usually to increase your chance of approval. The collateral means that if you can’t pay back the loan, the lender takes that asset.
- Funding Speed: This is how quickly you’ll have access to the money once your application is approved. This varies a lot by lender. Some will advertise same-day funds, others it might take up to a week. But expect a few business days unless advertised otherwise.
If you want to learn more about personal loan rates and how they’re determined, read our personal loan rates guide.
What Can You Use a Personal Loan For?
Here’s what borrowers commonly use their loan for:
- Debt consolidation (borrowers pay off multiple debts with the loan, then they only have to worry about paying back the loan, hence the term consolidation)
- Home renovations
- Weddings
- Emergencies
- Moving
- Medical or vet bills
- Large appliances
- Vacations (though this isn’t recommended)
You usually can’t use personal loans for things like paying for college, investments or a down payment on a house.
Personal Loan vs. Credit Card
Personal loans and credit cards are both ways to get money you have to pay back, but there are significant differences between the two. But the main difference is that personal loans are an installment credit while credit cards are revolving.
You have a set amount of money you’re borrowing with personal loans that you pay back in installments, or monthly payments, and you’re paying it back within a preset amount of time. Then your account is closed. Credit cards have a set credit line that you can borrow from, and once you pay it back, the credit line goes back to the original amount. Your account is only closed if you or the credit card company decides to close it. That’s what makes it revolving.
| Option | Interest rate | Set pay off date | Type | Use for |
| Personal Loan | Usually fixed | Yes | Installment | Large purchases to pay back over time |
| Credit Card | Usually variable | No | Revolving | Every day expenses you can pay back month to month |
Pros and Cons of a Personal Loan
Pros
- Fixed predictable payments
- Often lower rates than credit cards
- No collateral (unsecured)
- Flexible uses
- Can help credit mix
- Consolidates debt
Cons
- Interest rate can still be high
- Possible origination fees
- Hard inquiry at application
- Fixed payment lacks flexibility
- Need a good credit score for a better rate
Should You Get a Personal Loan?
Whether or not you should get a personal loan depends on several factors. Just because you can get a personal loan for certain things, doesn’t mean you should.
A personal loan makes the most sense for people who are trying to consolidate high-interest debt. If you can pay off all those debts with a personal loan that has a lower interest rate, you both save money and simplify your finances. Using it to make improvements to your home that add value can be beneficial in the long run. Personal loans also are sometimes the best choice for large purchases you can’t afford to pay in cash, but you can afford the monthly payments. For some this may be large appliances, weddings or emergencies like vet bills.
It’s not a good idea to get a personal loan if you wouldn’t be able to afford the monthly payments or you have a lower credit score that would result in a higher interest rate. Although you are allowed to use it for things like vacations, it’s not the best idea. Save up for your trip over time using something like a high-yield savings accountigh to help your money grow.
You also shouldn’t take out a personal loan with any company that guarantees approval or asks you for money up front. Those likely aren’t legit.
Our list of the best personal loans can also help you in your search.
How Do You Qualify for a Personal Loan?
Specific qualifications will depend on the lender. When it comes to what most lenders look at, that would be your credit score, income and debt-to-income ratio. They find out all this information through a soft credit pull, which won’t ding your score. You can expect a dip if you later decide to apply for the loan, because they run a hard inquiry. Comparing your options is easier if you use marketplaces like AmOne, which will match you with offers from top lenders.
Some lenders may have a minimum credit score or income, but not all. You also will likely need to provide ID, Social Security number, proof of address and proof of income. Our guide to how to get a personal loan explains the process more in-depth.
Frequently Asked Questions
Quite a few things — that flexibility is one of a personal loan’s main advantages. People most often use them to consolidate high-interest debt, pay for home improvements, cover an emergency or medical bill, or fund a major expense like a wedding. There are usually a few exceptions written into the loan agreement, such as college tuition, business costs, investing or anything illegal. But just because you can use a personal loan for something doesn’t mean you should — for discretionary wants like a vacation, saving up and paying cash usually costs less than borrowing.
No. A personal loan is installment credit. You borrow a fixed lump sum and repay it in equal monthly payments over a set term, usually at a fixed rate. A credit card is revolving credit. You draw money as you need it up to a limit, your balance and payment change month to month, and the rate is usually variable. Personal loans tend to be better for a known, one-time expense you want to pay off on a schedule, while credit cards suit ongoing, flexible spending — often at a higher interest rate.
Applying triggers a hard inquiry, which can cause a small, temporary dip, and taking on the loan adds to what you owe. But over time a personal loan can actually help your credit if you make on-time payments. Payment history is the biggest factor in your score — and using one to pay off credit cards can lower your credit utilization. You can check your rate with a soft-pull prequalification first, which won’t affect your score.
It depends on your credit and income. Borrowers with good credit and steady income usually qualify without much trouble and get the best rates. Those with weaker credit have fewer options and higher rates — though some lenders work with fair or bad credit. The easiest way to gauge your odds is to prequalify with a soft credit check before formally applying.
