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What is a personal loan and how do personal loans work?

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Sometimes you need to pay for an unexpected event, like a leaky roof, a car repair, or a medical bill. If you don’t have enough money set aside, these situations can be stressful. Fortunately, if you need cash quickly, you can apply for a personal loan. These loans give you access to money you can use for a variety of personal expenses. 

Key takeaways: How personal loans work

  • A personal loan is an amount of money that you borrow from a lender for things like home repairs, medical bills, large purchases, and other personal expenses.
  • A lender will typically look at your credit score and debt-to-income ratio to determine how much you qualify to borrow.
  • As a general rule: The higher your credit score, the lower your interest rate.
  • When you take out a personal loan, you’re responsible for paying it back in regularly scheduled payments.

If you’re in need of a personal loan, you’ve come to the right place.

Here’s what we’re going to cover:

  • What are personal loans?
  • How does a personal loan work?
  • What are personal loans used for?
  • How do I apply for a personal loan?
  • How does getting approved for a personal loan work?

What are personal loans?

Put simply, a personal loan is an amount of money that you borrow for personal expenses. It’s a type of installment loan that you pay back over time in set payments. You can apply for a personal loan from banks, credit unions, and state-licensed lenders.

There are two types of personal loans, secured and unsecured.

Unsecured personal loans don’t require collateral. In other words, they allow you to borrow money without putting your personal assets on the line. In general, unsecured personal loans are harder to qualify for than secured loans.

In contrast, secured personal loans require collateral. This collateral can be your home, your car, or something else of value that you own. If you fail to make your loan payments on time, your lender can take this collateral and apply it toward your payments. Collateral reduces risk for the lender and gives you an extra incentive to make your payments on time. As a result, a secured loan often has a lower interest rate than an unsecured loan.

Each lender has its own eligibility requirements and rates. So make sure to do your research and choose a lender that’s right for you.

How does a personal loan work?

Once you receive your personal loan, you start paying it back in regular installments until it is fully paid off. Personal loans typically come with fixed interest rates, repayment terms, and payments. Here’s what that means for you.

According to Experian, the average annual percentage rate (APR) on a personal loan from a bank or licensed lender is between 6­–36 percent. This is the money you’ll pay for taking out the loan. The APR is made up of the interest and fees on your loan. But what does that mean?

Interest is a percentage of the total loan amount that you pay just for taking out the money.

Fees are a part of the APR can include loan origination fees and processing fees. Additionally, not all lenders charge the same fees.

Your personal loan will typically come with a fixed term. This is the amount of time you have to pay off your loan. Most traditional personal loans have terms between 12 months and seven years. Your lender can’t alter this schedule once you’ve received your loan. As a result, you’ll enjoy predictable timely payments that can help you plan your budget with ease.

What are personal loans used for?

You can use a personal loan to pay for a wide range of household expenses. Some common uses include:

  • Emergencies and unexpected expenses
    Not everyone has an emergency fund set aside. If you need money for an emergency, a personal loan can be a lifesaver. It allows you to pay for your pet’s medical care, an urgent car repair, or other unexpected needs.
  • Large purchases
    If you want to make a large purchase, you may be tempted to pay for it with your credit card. But if your purchase will take months to pay off, it may be more cost-effective to use a personal loan instead. This way, you can pay for that new washing machine or even a family vacation at a lower interest rate.
  • Medical bills
    Medical bills can be expensive. Even when you have health insurance, your policy doesn’t cover everything. A personal loan can help you pay your medical bills on time and avoid collections, which can hurt your credit score. Dental work and other procedures that aren’t covered by your health insurance plan can be paid for with a personal loan.
  • Debt consolidation
    If you have credit card debt, you’re not alone. Over 170 million Americans hold credit cards. Credit card debt can be expensive, especially if you’re locked into a high interest rate. And if your credit card has a variable interest rate, it can be difficult to predict your monthly payments. By paying off your credit cards with a personal loan, you can bundle your debt into a single, predictable payment plan that may offer a lower interest rate.
  • Home improvements and repairs
    A personal loan can help you renovate your home or pay for costly home repairs. Unlike home equity loans, traditional personal loans are usually unsecured and don’t require your home as collateral, so there’s less risk to you.
  • Money owed to friends and family
    In tough times, you might borrow money from family or friends to pay your bills. While we all need this kind of support from time to time, it can be uncomfortable to owe money to someone you know. With a personal loan, you can pay back these debts and ease any tension or stress you feel about the situation.

As you can see, personal loans are useful in many different situations. They’re an effective way to reduce stress and help you regain control of your finances. 

How do I apply for a personal loan?

To apply for a personal loan, just follow these steps.

1. Check your credit report

Lenders want to know that you can pay back your loan on time. To determine this, most lenders start by looking at your credit score. Your credit score is a number between 300 and 850 that lenders use to decide whether you are likely to make your payments on time.

Before you apply for a personal loan, it’s a good idea to request your credit report. This allows you to look over your credit history and make sure there are no errors. If you do notice errors, let the credit bureau know right away. The bureau will help you correct the information, and that could raise your credit score before you apply. A higher credit score can mean a lower interest rate on your loan.

To check your credit report, go to AnnualCreditReport.com. This site allows you to get a credit report for free from each of the national credit bureaus once every 12 months. The three major credit bureaus in the United States are: 

  • Equifax
  • Experian
  • TransUnion

If you don’t have a credit score, that’s okay. Just make sure to read the section at the end of this article titled “How to take control of your finances with a personal loan from Oportun.” 

2. Do your research

Once you know your credit score, it’s time to find the right lender. Compare lenders online and look for ones that offer:

  • Low interest rates
  • Minimal origination fees
  • No prepayment penalties
  • Flexible payment schedules
  • Affordable payment plans
  • Great customer service

To get a customized loan offer from each lender, start by filling out the online prequalification application. If you prequalify, you should see your offer within minutes. The offer will usually explain which terms you’re eligible for. It may also show you specific details like the minimum loan amount, interest rate, and repayment term. Comparing this information can help you decide which lender will offer you the best deal.

3. Apply to the lender of your choice

Once you’ve chosen a lender, it’s time to submit your loan application and wait to see if you’re approved. 

After your application is approved, there’s one last step: Review the loan terms and sign the contract. Here are some important things to remember before you sign.

  • Read the fine print
  • Ask any and all questions you have about the loan
  • Ask about automated loan payments

Be sure all your questions have been answered to your satisfaction before you sign anything. A reputable lender will understand that it’s important for you to know exactly what you’re agreeing to.  

After everything is signed, you should receive your money fairly quickly. Some lenders make your money accessible within a few hours.

How does getting approved for a personal loan work?

Lenders want to feel assured that you will pay back your loan on time. If they believe you’ll make your payments on time, they’re more likely to approve your application.

When reviewing your personal loan application, most lenders consider your:

  • Credit report
  • Bank account activity
  • Payment history
  • Debt-to-income ratio (expenses vs. income)
  • Annual income (how much money you make each year)

If you have a good credit score and a low debt-to-income ratio, it’s easier to get approved for a loan and qualify for lower interest rates.

If you don’t have these things, you still have options. You can increase your chances of getting approved by applying for a secured loan or applying with a cosigner who has a high credit score. A cosigner is often a family member who is willing to put their name on a loan application with you. This person shares responsibility for paying back the loan.

Oportun: Affordable lending options designed with you in mind

Now that you understand what a personal loan is and how personal loans work, you can learn about how Oportun may be able to help you if you’re looking for affordable credit options.  Visit our homepage to learn about:

  • Personal loans
  • Secured personal loans
  • Credit cards
  • And more!



Experian. What’s a good personal loan interest rate?

Consumer Financial Protection Bureau. CFPB spotlights concerns with medical debt collection and reporting

Consumer Financial Protection Bureau. The consumer credit card market

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