There are plenty of things in life that we can’t afford with our day-to-day budget—cars break down, plumbing problems bubble up, a new apartment requires a hefty security deposit, or high-interest credit card debt has become a big burden.
If you don’t have the money you need saved up, what can you do? A personal loan just might help. Applying for a personal loan allows you to make a purchase now and pay for it over time. And, because a personal loan works differently than credit cards, it can be a better choice for certain situations—like when those very credit card bills are the strain on your budget!
Whether you’re looking to consolidate and pay off credit card debt or need to cover an emergency expense, a personal loan might make sense. But taking out a loan is a big decision, and you should do a lot of research before you apply for one to ensure that it’s really the right choice for you. Read on to get the low-down on how personal loans work and what they might mean for your financial picture.
Tip: We’ve put a glossary at the end of the article to help you better understand personal loan lingo.
What is a personal loan and how does it work?
Basically, applying for a personal loan means borrowing an amount of money and then paying it back (with interest) over a fixed period of time.
To get more detailed: A personal loan is a sum of money (aka, principal amount) that a creditor lends to a borrower at a certain interest rate for a specific period of time (also called a term). The lender will require that you pay back what you borrowed, plus interest and fees, in installments (through a fixed monthly payment).
Generally, personal loan interest rates are fixed (aka, always stay the same). Other forms of credit (like credit cards or other types of loans) may have rates that are fixed or variable (i.e., the rate may change at any time based on things like the economic market). If you need predictability in your budget, a personal loan can be a smart choice because of the fixed interest rate—you’ll always know exactly what you’ll pay.
Unlike the kind of loans that have a very specific purpose (e.g., a student loan or mortgage), a personal loan can be used for a variety of things, such as consolidating credit card debt or covering a big, unexpected car repair.
Where do I apply for a personal loan?
You can apply for a personal loan from online lenders, banks, and credit unions. Brick-and-mortar banks and credit unions usually require an in-person visit, though some might have an online application option. With an online lender, you simply apply online.
What is the interest rate on a personal loan?
Interest rates for a personal loan vary from lender to lender, and the rate you can get also depends on your credit score and other factors. One of the main benefits of getting a personal loan instead of a credit card is that personal loans typically have lower interest rates.
Another way to spend less on interest: find loan providers that offer a discount on interest if you set up auto-payments. This perk means that you’ll pay less in interest on your loan and you won’t have to worry about forgetting to make your loan payment each month.
That said, the interest rate on a personal loan doesn’t tell the whole story. To really understand the cost of borrowing money (and to compare different loan options), you’ll want to look at the Annual Percentage Rate (APR).
What is the difference between APR and interest rate on a personal loan?
When you find out the interest rate on the loan, you’ll also be told the APR. While these terms sound similar, there’s an important distinction. The interest rate is the percentage that you’re charged for borrowing the money. This percentage is applied to your loan balance, and you pay it back along with your principal when you make monthly payments.
The APR, on the other hand, is the annual cost of borrowing the money, and includes your interest rate plus any other finance charges. All lenders are required by law to disclose the APR in the same way, so use that number to compare options when you shop around for the best rates.
The APR represents the full cost of borrowing money because it includes the fees as well as the interest (including compounded interest). You want to find the lowest APR you can to get the best deal.
How long do I have to pay back a personal loan?
It depends on the lender and term you set up, but a personal loan usually has to be paid back within one to five years, according to NerdWallet.
The amount of time you have to pay back your loan is known as the loan term. Unlike credit cards, personal loans have fixed terms, meaning that you have a set amount of time to pay it off. The advantage of a fixed term is that you know exactly how long it will take to pay back your loan.
Since personal loans have a fixed term and rate, your monthly payment will be the same every month for a specified number of months—making budgeting a lot easier (and you can set up an Expense in your Simple Account to make it effortless).
Are there different types of personal loans?
Yep! You can get either a secured or unsecured personal loan:
- Secured: You “back” the loan with something you own, like a certificate of deposit (CD) or money in your savings account. Whatever you use to back the loan is called collateral. If you default on your loan, the lender could assume or seize that collateral.
- Unsecured: With an unsecured loan, you don’t “back” the personal loan or provide collateral. If you miss payments, you’re likely to face late charges and take a hit to your credit score, but you won’t lose your property.
Most personal loans are unsecured; you’re more likely to encounter secured loans if you’re looking for a car loan, mortgage, or home equity loan.
What can you use a personal loan for?
Just about anything you want, but here are some common uses for personal loans:
- Consolidate credit card debt
- Pay off medical bills
- Cover emergencies like car repairs
- Pay for your wedding or other big life event
If the interest rates on your credit cards is high, it can be tough to feel like you’re making headway when you start trying to pay them off. That’s why consolidating debt is one of the most popular ways to use a personal loan (and with good reason; credit card debt in the US totaled more than $1.04 trillion in 2019). But what does debt consolidation through a personal loan actually mean?
In short, you use the funds from a personal loan (with a fixed term and lower interest rate than you’re paying on your credit cards) to pay off your credit cards—then you just make a single monthly payment on your loan for a fixed amount of time.
For example, say you have four credit cards with a balance of thousands of dollars on them altogether. You could use a personal loan to pay off these cards. Then, instead of making payments on several different credit cards, you’d make one monthly payment on your personal loan. Consolidating debt with a personal loan typically means you’ll pay a lot less in interest and potentially get out of debt faster.* Plus, it’s much easier to keep track of your debt when you have just one loan payment every month.
How much does it cost to apply for a personal loan?
When you borrow money from a lender, you have to pay back the amount you borrowed, plus more. Much of the “cost” of the loan is in the form of the interest you pay. But, as we mentioned above, there are often fees as well (that’s where the APR comes in).
For loans that do have fees, the most common one is called an origination fee. This is a fee that the lender charges simply for loaning you the money. Origination fees vary widely, so be sure to read the fine print.
Other possible fees vary widely by lender, so carefully check the loan’s terms so you understand exactly what you’ll be paying. And remember that some loans don’t have any fees, which lowers the cost of borrowing money.
How do you know if you qualify for a personal loan?
Once you submit an application, lenders will generally look at your credit history and income level to determine whether they meet their requirements. They also review this information to decide how much money you’re qualified to borrow and what interest rate they’ll offer you.
Every lender has different guidelines and criteria for determining who qualifies for a loan. And different lenders offer different options (such as secured and unsecured loans). The best way to find out whether you might qualify for a loan is to contact the lender and ask about their specific requirements. Many lenders let you find out if you qualify for a personal loan without it affecting your credit score.
Note that you might get a letter or email from a lender saying that you’re pre-qualified for a loan. This means that the lender has done a “pre-screening” and determined that you’re likely to qualify. Read more detail in our blog post on common loan terms.
How do I apply for a personal loan?
With an online lender, you simply fill out an application form on their website. Brick-and-mortar lenders might have an online application process, but may require you to visit a branch to apply instead.
Many online lenders will allow you to check your loan options (such as your interest rate and amount you could borrow) before you complete an application. Checking your options in this way won’t affect your credit score because they do what’s called a “soft pull.” Once you go ahead and fill out the application, the lender will do a “hard inquiry” (a formal review of your credit score) when they process your application.
When you’re ready to apply, you’ll need to provide a variety of personal information; in some cases you’ll be asked for documentation (such as your most recent pay stub).
After you apply, the lender will process your application and let you know if you’ve qualified; it may take a few hours or a few days, depending on the lender. If you’re approved, the money could be deposited into your bank account within a few days—and some lenders offer same-day funding when you’re approved!
Is a personal loan right for you?
A personal loan can be a great option to pay for things you need but can’t afford immediately out of pocket—especially unexpected large expenses like a broken furnace or windshield. Personal loans may also be smart options for consolidating debt from multiple high-interest credit cards.
Also consider when a personal loan is NOT a good idea: to splurge on something you want or have extra cash (after all, you have to start paying back that extra cash right away, plus interest). If you want to fund something like a vacation or holiday gifts, it might be smarter to start a savings goal and set aside a bit of money every month for the things you want.
With a Simple Personal Loan, you won’t pay an origination fee or early payoff fees, and you can manage your loan entirely online. Currently the Simple Personal Loans are only for pre-approved Simple customers.
Personal loan glossary
Annual percentage rate (APR): The yearly rate (expressed as a percentage) that you’re charged for borrowing the loan, including interest rates and fees
Collateral: Any asset (e.g., a Certificate of Deposit, savings account, or personal property) that backs your loan. Collateral is used for secured loans
Credit history: A record showing your borrowing and repayment history
Credit report: A breakdown of your credit history (including things like your personal information, lines of credit, and financial details), which is prepared by a credit bureau
Credit score: A number determined by credit reference agencies or data analytics companies that represents your creditworthiness based on your credit history. Credit scores range from 300–850; the higher your score, the more creditworthy you are (i.e., how likely you are, in the eyes of lenders, to be able to pay back credit)
Fixed monthly payment: A monthly payment due to the lender that does not change throughout your loan term
Lender (aka, Creditor): The bank, credit union, or financial institution from whom you borrow money
Principal amount: The amount of money that you borrow (not including interest or fees)
Secured loan: A loan that must be backed with collateral
Term: The exact amount of time you have to pay back the loan (usually between one and five years)
Fixed interest rate: An interest rate that stays the same throughout the life of the loan
Origination fee: A fee that the lender charges for creating and processing the loan
Unsecured loan: A loan that is not backed by collateral
For an in-depth explanation of what these terms mean for you, take a look at this full breakdown.
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The relative benefits you receive from debt consolidation will vary depending on your individual circumstances, including the interest rate and remaining term on your existing debts. Consolidating multiple debts may not reduce your interest costs or pay your debt off sooner. For example, if your personal loan has a longer term than the debts you are consolidating, you may not realize savings over the entire term of your new personal loan.
Disclaimer: Hey! Welcome to our disclaimer. Here’s what you need to know to safely consume this blog post: We do our best to make sure information is accurate as of the date of publication, but things do change quickly sometimes. Any outbound links in this post will take you away from Simple.com, to external sites in the wilds of the internet; neither Simple nor our partner bank, BBVA USA, endorse any linked-to websites; and we didn’t pay/barter with/bribe anyone to appear in this post. Individual situations will differ; consult your favorite finance, tax or legal professional for specific advice. And as much as we wish we could control the cost of things, any prices in this article are just estimates. Actual prices are up to retailers, manufacturers, and other people who’ve been granted magical powers over digits and dollar signs.