What Is a Personal Loan?

A personal loan is a type of loan that you can take out from a bank or private lender for a wide variety of purposes. The loan typically isn’t secured by collateral, which means you can basically use the funds at your discretion.

While you can use an unsecured personal loan for something frivolous like a vacation, taking out a personal loan still involves going into debt — so it’s best to save them for absolutely necessary expenses or for money management tactics like debt consolidation.

Below we dive deeper into what a personal loan is and how you can get one.

Definition of a Personal Loan

What is a personal loan? A personal loan is an extension of closed-end credit — typically a lump sum of cash given to creditworthy borrowers — that you can use for personal, family, or household purposes. Borrowers are expected to repay a personal loan over a set term, including principal, fees, and interest charges.

How Does a Personal Loan Work?

Now that we know a little bit more about what personal loans are, let’s talk about how they work. 

What typically happens is that you apply for a personal loan, and if the financial institution approves you, they’ll offer you the money upfront in exchange for interest you’ll pay over time (along with paying back the principal, or original loan amount). The interest rate may be fixed, meaning it will always stay the same, or variable, meaning it will fluctuate depending on the market. Fixed-rate loans always have the same monthly payment, while the monthly bill may shift if you’ve taken out a variable-rate loan.

Personal loans are paid back in regular monthly payments, or installments, which is why they’re also sometimes known as installment loans. (Other types of loans paid in monthly chunks, including student loans and mortgages, are also installment loans.)

Secured vs. Unsecured

Lenders can offer secured and unsecured personal loans. The difference between secured vs. unsecured personal loans is that you must pledge assets as collateral to obtain a secured personal loan.

Personal property you own — such as cars, real estate, or fine jewelry — can serve as collateral for a secured personal loan. Lenders may seize your collateral if you default on a secured loan. 

An unsecured personal loan doesn’t require any collateral. Because unsecured personal loans are inherently riskier to the lender (since there’s nothing to repossess), they tend to come at a higher cost. They can also be more difficult to qualify for, particularly if your credit history needs some work or you’re already in a lot of debt.

Personal Loan Use Cases

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

• Making home renovations or repairs that could increase the value of your property

• Paying off medical bills, including financing weight loss surgery, or emergency expenses you would otherwise need to put on credit

• Using a personal loan to consolidate other existing debts, such as credit card debt, which could help you save money in interest over time, pay off your debts more quickly, and simplify your repayment strategy

• Covering closing costs on a home

• Paying off a TSP loan early

While it may be tempting to take out a personal loan for a vacation, major event, or shopping spree, the potential interest charges can add up. And if you’re purchasing something you can use as collateral — like a car — you’ll almost always find better interest rates and terms with a secured loan than an unsecured personal loan.

Recommended: Using a Personal Loan for Tiny Home Financing

How To Get a Personal Loan

Here are some steps you can take if you’re looking for personal loan offers:

• Prequalification. Check whether you have any prequalified loan options with an online lender or platform. This typically does not affect your credit score.

• Gather documents. You’ll generally need proof of income and proof of identity when applying for consumer loans. You can present pay stubs, bank statements, or W-2s as proof of income and a driver’s license and Social Security card as proof of identity.

• Submit application. At this step you can select a prequalified personal loan offer and apply for funding. This will typically involve a hard inquiry into your credit report, which can cause your credit score to drop by several points.

• Accept the loan. If approved, you can sign and accept your loan offer. Online lenders typically disburse the funds within one to three business days following loan approval.

What To Look for When Comparing Lenders

If you’re shopping for a personal loan, here are three things to look for when comparing lenders:

1. Look for Lower Interest Rates

You’ll obviously want to keep an eye out for options with lower interest rates. Some lenders may offer personal loans with annual percentage rates (APRs) ranging from 7.99% to 35.99%, so it’s worth comparing lenders to see who can offer you the best rate. A percentage point or two might not seem like that much of a difference, but it can certainly add up over the life of the loan.

2. Don’t Forget to Look at Fees

Interest rates aren’t the only factor to keep in mind — fees are also critical to consider. Some lenders may charge steep origination fees as part of your APR.

3. Remember Each Lender Has Its Own Policies

Keep in mind, too, that each lender has its own policies as far as the maximum loan amount available, loan terms (the length of time over which the loan is repaid), and more. Shopping around can help you find the loan product that’s best suited to your specific needs. Some lenders may offer joint personal loans, while others may not.

Personal Loan Application Process

Applying for personal loans is usually a pretty easy process, especially in today’s digital world. You’ll be asked to provide basic demographic information, such as your name, date of birth, and home address, as well as financial information, such as your employment history and income. 

In some cases, you may be able to obtain preapproval for personal loans without a hard credit check. This can help you check your rate and loan offers without any obligation to apply. Applying for a prequalified loan offer, however, will typically involve a hard credit check that can hurt your credit score.

3 Tips for Qualifying for a Personal Loan

Wondering how you can increase your odds of qualifying for a personal loan? Here are a few tips:

1. Build Credit Before Applying

Your credit history matters when it comes to qualifying for a personal loan (and getting the best deal once you do), so building your credit before applying can be helpful if you have the means to do so.

2. Make an Effort to Lower Your Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is another factor lenders use when qualifying you for a loan, so if you’re able to pay off some existing debts before applying, that could help, too.

3. Consider a Cosigner

If you have bad credit or no credit, getting a creditworthy cosigner may strengthen your personal loan application. Their credit score and income could increase the likelihood that a lender will approve you for a loan. Just remember that if you fail to make timely payments, your cosigner will be on the hook.

Alternatives to Personal Loans

While personal loans can be a great tool in certain situations, it’s always worth looking into alternatives before going into debt — particularly at high interest rates.

So if the expense you’re facing is a true emergency and you’re lucky enough to have an emergency fund saved up, it’s worth seeing if you can cover the costs in cash.

If that’s not possible, you might look into a 401(k) loan, which draws from your retirement fund, or a salary advance, which involves getting your regular paycheck earlier than you would otherwise. Of course, these options have their own drawbacks and benefits to consider, too, so it’s important to do your research.

The Takeaway

Taking out a personal loan comes at a cost, so it’s a big decision. In some cases, it might be the right one for your financial needs — particularly if you’re consolidating existing debt.

If you need a personal loan, Lantern by SoFi can help. Just fill out a simple form and compare prequalified loan offers in our marketplace.

Lantern can help you find online personal loans.