What Is a Personal Loan?

Q: Does getting a personal loan affect your credit score?

Like all forms of debt, a personal loan can affect your credit, particularly if you fail to make required payments when due. Taking out a large personal loan can also increase your debt-to-income ratio, which can make it harder to qualify for future financing. Also keep in mind that when you apply for a personal loan, the bank or nonbank private lender may do a hard inquiry when they pull your credit, which can ding your score by a few points and remain on your credit report for up to two years.

Q: What is the minimum credit score needed for a personal loan?

Some lenders may offer subprime personal loans to borrowers with FICO® Scores of 619 or below. Loan approval is never guaranteed, and lenders can set their own underwriting standards.

Q: Is a personal loan better than a credit card?

Your personal circumstances may determine whether a personal loan is right for you. Subprime personal loans can have APRs as high as 35.99%, whereas some credit cards may offer introductory 0% APR for a limited duration. Interest may accrue daily on a personal loan balance, whereas you can typically avoid credit card interest charges on new purchases if you pay your statement balance in full each billing cycle. Some credit cards can also come with rewards and other benefits that you might not get with a personal loan offer.

Jamie CattanachUpdated February 24, 2024

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

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 pretty much 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 you apply for a personal loan, and if the financial institution approves you, they’ll offer you the money up front 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.)Recommended: 10 Possible Benefits of Obtaining Personal 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.Recommended: Is Taking Out a Personal Loan Bad?

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 four business days following loan approval.

What To Look for When Comparing Lenders

When 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 8.99% 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 the loan is repaid over), 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.Recommended: What Is a Retail Lender? How Retail Loans Work

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, 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.Recommended: What Are Your Residency Relocation Loan Options?

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.Recommended: How Many Personal Loans Can You Have at Once?

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.Recommended: Home Equity Loans vs Personal Loans: Which One Is Right for You?

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.

Frequently Asked Questions

Does getting a personal loan affect your credit score?

What is the minimum credit score needed for a personal loan?

Is a personal loan better than a credit card?

Photo credit: iStock/PeopleImages

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About the Author

Jamie Cattanach

Jamie Cattanach is a full-time freelance writer whose work has been featured at CNBC, Yahoo Finance, The Motley Fool, the Huffington Post and other outlets. At SoFi, she writes about investing, retirement, student loans and how to get your money right -- no matter what that means for you.

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