How do personal loans work?

Personal loans are a way to borrow several hundreds of dollars to several thousands for a wide range of expenses. And since personal loans have lower rates than credit cards, according to Federal Reserve data, they can be a much more affordable borrowing option, as well as a great way to refinance high-interest credit card debt.

What is a personal loan?

A personal loan is a type of installment loan offered by a wide range of banks, credit unions, and online lenders. They provide a lump sum of money up front that you can use for almost any purpose, depending on the lender (some lenders only approve loans for specific purposes, like debt consolidation). Since most are unsecured, you don’t need to provide any collateral, and loan approval can be quick — as soon as the same day you apply, in many cases.

As for repayment, the loan amount and interest are typically split into fixed monthly payments over a set term. Unlike credit cards, interest rates are usually fixed as well, which means you don’t have to worry about the rate increasing. In some cases, lenders also charge up-front fees — like origination fees.

Here's a breakdown of common personal loan features:

• APRs: APRs on most personal loans are between 7% and 36%, and fluctuate as interest rates rise and fall. The APR takes both the interest rate and any up-front fees, like an origination or administrative fee, into account, which makes it a good way to compare overall borrowing costs between loans and lenders.
• Repayment terms: Terms vary by lender, but are often available between 1 and 7 years. Personal loans used for home improvement could have repayment terms up to 12 years or longer.
• Loan amount: Available loan amounts vary by lender; the amount you'll qualify for depends on your income, current debt, and credit, among other factors. Many lenders offer personal loans up to $50,000. Some offer $100,000 personal loans or more. You can also find small personal loans for less than $5,000.
• Fees: Many lenders charge late fees and insufficient funds fees. Some also charge an origination fee. An origination fee is a percentage of the loan amount that's deducted up front. They vary by lender, and could be as high as 12%. An origination fee is one way a lender can minimize its risk on a loan, which is why bad-credit and fair-credit borrowers may pay higher origination fees compared to borrowers with good credit. 
• Time to fund: Many lenders fund personal loans within 1 to 2 business days of approval. But some lenders offer same-day funding for approved applications submitted before a cutoff time. Other lenders could take up to a week to fund. 
• Loan purpose: While personal loans can be used for a wide range of purposes (except for tuition and as a down payment), not all lenders approve all generally permitted loan purposes. Most lenders ask what you want to use the loan for in their prequalification process and provide a list of options. If your intended loan purpose is not on the list, it's possible the lender won't approve it. 

Personal loan types

There are a few different varieties of personal loan available. These are some of the most common:

1. Unsecured personal loan: This is the type discussed above, and is the most common type of personal loan.
2. Secured personal loan: A few lenders offer personal loans secured by an asset, such as your car or savings account. Secured loans can make sense if you want to lower your rate or are struggling to qualify. But not all lenders offer them.
3. Cosigned loan: A cosigner is someone who applies for the loan with you. They share equal responsibility (in the lender’s eyes) for repayment, but do not share the loan funds. A cosigner with good credit can help you get approved for a personal loan, but they’re on the hook if you miss payments. Their credit will suffer along with yours if you make late payments as well.
4. Credit-builder loan: This is more like a reverse personal loan, and is designed for those who can’t get approved for a regular personal loan or want to rebuild their credit. Instead of receiving money up front, you only get the loan funds until after you’ve finished making payments on the loan, with interest.

Common personal loan uses

Personal loans can be used for a wide variety of expenses. It’s actually easier to say what they can’t be used for than to cover everything they can. Generally speaking, you can’t use a personal loan to pay for tuition or a down payment on a home, and many lenders restrict use for business expenses as well.

Here are some of the most common personal loan uses:

Home improvement projects

Home improvements can be expensive, making them hard to cover out of pocket. By taking out a personal loan, you can split the costs up over time at a rate that’s often less than the rate on a credit card. While home equity loans tend to come with even lower rates, personal loans can be better if you don’t yet have enough equity in your home, want to avoid closing costs and a lengthy approval process, or don’t want to take out a second mortgage.

Debt consolidation

Personal loans can also offer a helpful way to streamline the repayment of multiple debts. For example, suppose you have a credit card with a $2,000 balance, a medical bill with a $500 balance, and an Affirm loan with a $700 balance. If you can get approved for a $3,200 debt consolidation loan, you could use it to pay off all three debts. Then, you’d have one monthly payment instead of three. Further, if you can get an APR lower than the APR on your existing debts, you may be able to save money on repayment.

Emergency expenses

Sometimes life throws you an expensive curveball, like an emergency room visit, broken refrigerator, cracked windshield, or sick pet. When you can’t comfortably pay for something out-of-pocket or don’t want to, personal loans offer a way to split it up over time. With loan amounts ranging from $600 to over $100,000, they’re versatile and can come in handy for a wide variety of situations.

Large purchases

If you need (or want) to make a large purchase that you might otherwise put on a card, a personal loan could be a better option. Weddings, vacations, a new laptop, or a new bike are just a few items you can buy with a personal loan. Just note that not all lenders allow all loan purposes, so be sure to make sure any lender you’re considering allows you to use the money how you want.

Personal loan rates

Personal loan costs are expressed in terms of APR, which tells you how much you’ll pay per year if the interest and upfront fees were broken up evenly over your loan term. Personal loan rates generally range between 7% APR and 36% APR. But the APR a lender offers is based on a variety of factors including your creditworthiness, the loan amount you request, your income, the length of the repayment term, and more. 

That said, average rates are most impacted by credit score. For example, the average personal loan interest rate on three-year loans was 12.54% for applicants with FICO scores over 780 in April 2024. However, for FICO scores between 600 and 639, the average rate was 31.55%.

Personal loan eligibility

To qualify for a personal loan, you’ll have to meet the lender’s eligibility requirements. While they vary by lender, most will review your credit scores, credit reports, income, employment situation, and debt-to-income ratio to assess the amount of risk you present. The higher your risk level, the more personal loans will cost and the lower your chance of approval. That said, some lenders specialize in extending loans to borrowers who present more risk, so don’t rule yourself out if you need a personal loan with bad credit.

Prequalify before you apply to get a sense of whether you’re eligible for a personal loan and the rates you might qualify for.

How to compare personal loans

If you decide a personal loan is right for you, you should know that there are many lenders to choose from. They vary not only in who they approve but also in the loan amounts, APRs, and loan terms they offer. So to find a competitive deal, you’ll usually need to shop around.

But where do you start? You can visit lenders' websites one by one, review their eligibility requirements, and request quotes. Or, to speed things up, you can use a loan marketplace to collect quotes from a wide range of lenders in one go. Once you have multiple quotes, review them carefully, paying special attention to the following factors:

• Loan amount: Does the lender offer the amount you need? Will you need to borrow too much or too little?
• Loan term: Does the loan term meet your needs? Is it too long or too short?
• APR: Is the APR competitive? The lower, the better.
• Fees: Does the lender charge any upfront fees like origination fees? How do other fees, like late fees and insufficient funds fees compare?
• Monthly payment amount: Does the monthly payment amount fit into your budget? Is it the lowest available to you?
• Overall cost: How much will the loan cost you overall? Is it competitive in comparison to your other quotes? Lenders may not include the overall loan cost. If they don’t, you can quickly figure it out using a personal loan calculator. 

How to apply for a personal loan

1. Check your credit: If you want to apply for a personal loan, the first step is to check your credit. Look over your reports and scores to ensure everything is accurate and in good shape. If you find any errors, you can dispute them with the credit bureaus. Also, look for ways to quickly improve your scores, such as paying down revolving credit lines or taking advantage of the Experian Boost program.
2. Research lenders: Find lenders that offer the terms you need, such as loan amount, repayment term, and time to fund. Then, check that you meet their minimum credit score and income requirements, and make sure they will approve your intended loan purpose. 
3. Prequalify with lenders: Once you have a few potentials, start collecting quotes from lenders. This is where you'll prequalify. You'll likely have to provide personal information, such as your Social Security number, to get customized rates. But your credit won't be impacted. Then, you can go back to the winning lender’s website to apply once you've compared quotes. 
4. Apply: During the full application process, lenders will typically ask for more details about your income, debts, and employment. Further, they may request proof such as pay stubs, tax returns, or utility bills. The process also involves a hard credit check which may cause your credit score to drop by a few points.

Once you finish the full application, the lender will provide you with a final decision. If you get approved, the loan will be sent to your bank account according to the lender’s funding times.

Personal loan example

Here’s a look at how a personal loan works in practice.

Let’s suppose you have decent credit and apply for a $10,000 personal loan. After shopping around, you decide on a loan that has a five-year term and a 24% APR. If the loan doesn’t have an origination fee, your monthly payment amount would be about $288 per month and your overall loan cost would total $7,261.

On the other hand, let’s suppose the loan does have a 5% origination fee ($500) but still has a 24% APR. The lender would deduct the $500 origination fee from your loan before you receive it, so you would only get $9,500. Note that you still have to repay the full $10,000 principal loan amount. Your ongoing interest rate would then be lower, 21.5%, because your APR includes the origination fee.

As a result, your monthly payments would land around $273 and the overall cost would be about $6,901. While this is slightly lower than the example above, in this case you only truly borrowed $9,500.

Personal loan alternatives

Not sure if a personal loan is the right fit? Don’t worry. You can finance personal expenses using other credit products such as a credit card, a cash advance app, or a buy now, pay later (BNPL) loan.

• Credit cards: Credit cards provide you with a revolving credit line that you can use, repay, and use again. They can be good for short-term financing. If you pay off the balance within 1 month, you can avoid interest charges. Some card issuers also offer 0% APR promotional periods which allow you to finance purchases over an extended period without paying any interest.
• Cash advance apps: Cash advance apps like EarnIn and MoneyLion allow you to get small cash advances between paychecks, often $700 or less. These can help bridge gaps between paychecks. Unlike many loan products, eligibility is often based on your bank account transaction history rather than your credit. Just watch out for expensive instant transfer fees.
• “Buy now, pay later” (BNPL) loans: BNPL services like Afterpay and Affirm have become increasingly popular. They allow you to break up purchases into smaller payments over time, sometimes without interest charges. You can initiate purchases through BNPL apps or may find them as a payment option during checkout at certain retailers.

Frequently asked questions

What can you use a personal loan for?

A personal loan can be used for personal expenses of your choice. For example, you could use one to finance the cost of car repairs, new clothes, a vacation, a wedding, or a move. Lenders typically only have a few restrictions on the use of the funds, such as forbidding them to be used to fund illegal activities, a new business, college tuition, or gambling.

How long does it take to get a personal loan?

It’s possible to apply for a personal loan, get approved, and have the funds in your bank account as soon as the same day. However, application and funding times vary by lender. They often range from one to three business days.

Is a personal loan better than a credit card?

Personal loans offer a few advantages over credit cards, including lower average interest rates, large loan amounts, and a fixed repayment schedule. They’ll often be cheaper when making large purchases that you want to pay off over time, unless you qualify for a 0% APR promotion on a credit card and can pay off the balance within the term.