What's a personal loan, and how does it work?

A personal loan allows you to borrow the money you need to handle a wide range of costs, such as a home renovation, unexpected trip to the veterinarian or a major car repair. But before you sign on the dotted line, review this explainer from OneMain Financial detailing what personal loans are and how they work so you can make the best choice for your financial situation. 

What is a personal loan?

A personal loan is a lump sum of money that you repay in monthly installments with interest (the cost of borrowing). You may get a personal loan from a lender, bank or credit union. A personal loan can be used for almost anything, from handling a large one-time expense to managing ongoing household bills. Personal loans usually come with fixed interest rates, which means you can pay off your loan in predictable monthly payment amounts with a clear payoff date, as long as you pay on time, every time.

Secured and unsecured personal loans

Some lenders offer secured and unsecured personal loans to fit your goals and financial situation.

A secured loan is backed by collateral, which is something valuable you possess, like a car or truck. With a secured loan, you might boost your borrowing power by qualifying for a lower interest rate or a higher loan amount than you would with an unsecured loan. Keep in mind that if you don’t pay back your loan, the lender can take possession of your collateral to recover the remaining amount owed.

An unsecured loan doesn’t require collateral. Instead, lenders look more closely at factors like your credit history and income to decide if you qualify.

How much can you borrow with a personal loan?

The amount you can borrow with a personal loan can vary by lender, with some offering loan amounts from $1,500 to $30,000. Repayment terms vary, but they often range from two to five years.

What can you use a personal loan for?

You can use a personal loan for a wide variety of purposes, including:

• Emergency expenses
• Debt consolidation
• Moving costs
• Car repairs
• Weddings and major life events
• Booking vacations
• Home repairs, renovations and maintenance
• Household expenses and bills.

Most lenders have some rules on how a personal loan can be used. For example, many lenders don’t offer personal loans for postsecondary educational expenses or business use. If you’re not sure whether you can use a personal loan for the expense you have in mind, ask your lender about its policies.

How does a personal loan application work?

As a first step, some lenders may allow you to check for prequalified offers to get an idea of the kind of loan you might be offered once you officially apply. Prequalification involves a soft credit check that doesn’t affect your credit score.

You can usually apply for a personal loan online, by phone or in person. During the application process, you’ll provide certain details, such as your contact information and income information. The lender will perform a hard credit check, which may lower your credit score by a few points and could stay on your credit report for up to two years.

If your application is approved, you’ll receive your funds, often via a debit card, direct deposit or a paper check. Depending on the method and lender, the time it takes to get your money may vary. In most cases, you can receive funds quickly, usually within a week.

What fees are associated with personal loans?

How much a lender charges in fees for a personal loan can vary, but these are some common types you might see:

• Origination fee: A one-time fee for processing an application and setting up the loan. This fee could either be a flat amount or a percentage of the loan amount.
• Late payment fee: A fee applied when a payment is made after it’s due. Some lenders won’t charge it until after a specified number of days after the due date. This fee can either be a flat amount, a percentage of your entire monthly payment amount or a percentage of the delinquent portion of your monthly payment amount.
• Nonsufficient funds (NSF) fee: A fee applied when a payment made by check or electronic Automated Clearing House (ACH) debit is returned due to insufficient funds. The amount varies depending on state law.
• Prepayment penalty: A fee some lenders charge if you pay off your full loan balance early. Each lender has their own way of calculating this type of fee — if they charge it at all.

Lenders are required to be up front about their fees and terms so that you understand exactly when and why you might be charged a fee. Make sure you’re comfortable with these conditions before signing your loan agreement, and contact the lender directly if you have any questions.

How do you repay a personal loan?

Personal loans are typically repaid in monthly installments over a set term, often 2 to 5 years. Each payment is calculated based on the principal (the amount you borrowed) and interest for the agreed-upon term.

Most personal loans have a fixed interest rate, meaning your interest rate will stay the same over the term of your loan — and so will your monthly payment, as long as you make your payments on time.

Some lenders also offer personal loans with variable interest rates, meaning the interest rate fluctuates with the market, but fixed-rate loans are more common.

Is a personal loan right for you?

Everyone’s finances, goals and responsibilities look a little different, so it’s important to take a close look at your full financial picture. Before deciding whether to apply, think about how a monthly loan payment would fit into your budget and how deciding to borrow may impact your current financial goals.

When it might make sense to apply for a personal loan

In some cases, a personal loan could offer a practical path forward. You might be ready to apply for a personal loan when:

• You’ve compared other borrowing options: You’ve determined that a personal loan is the best fit for your needs based on how you’re planning to use the funds and the amount of money you need.
• You have a repayment plan: You understand a personal loan’s repayment timeline and have a strategy to stay on track with monthly payments.
• You understand the total cost of borrowing: You’re clear on how interest and fees factor into personal loan payments.
• The loan fits your budget: You’ve estimated monthly payments and believe you can afford them.

Get the funds you need with a personal loan

Now that you know what a personal loan is and how they work, you can make a smart borrowing decision for your budget. If you’re still not certain whether a personal loan is the right fit for you, a personal loan calculator can help you estimate your monthly payments.

This story was produced by OneMain Financial and reviewed and distributed by Stacker.