How Do Personal Loans Work?

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• Unlike credit cards, personal loans offer a fixed interest rates and monthly payments.
• Personal loans can be used for debt consolidation or major home remodeling projects.
• Most personal loans are unsecured, meaning you don't have to put down collateral to borrow money. 

When you need cash, there are several reasonable ways to get it.

You may be able to get a small loan from family or friends, and you can always apply for a credit card. But, there's another option to consider that comes with certain advantages: a personal loan. While personal loans may have gotten a bad rap in some circles, they can offer a predictable way to borrow money.

See Insider's picks for the best personal loans >>

What is a personal loan?

A personal loan is money you borrow from a bank, credit union, or online lender that you repay with interest over a set period of time. Personal loans are installment loans, like mortgages and car loans. In other words, all the money is issued up front and you repay the loan with fixed payments over a predetermined loan period.

Unlike many other types of installment loans, however, unsecured personal loans are standard, like credit card debt. That means you don't need to provide any collateral. Average personal loan interest rates tend to be higher than the rates on secured loans but lower than credit card interest rates.

How do personal loans work?

Personal loans let you borrow a predetermined amount of money with a fixed interest rate and a fixed repayment period. They also come with fixed monthly payments that you agree to ahead of time, which makes budgeting for your loan a whole lot easier. This is also the main difference between personal loans and lines of credit in general.

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Personal loans with low interest rates are possible if you have good credit.

Here are the most important details you need to know about unsecured personal loans:

• You borrow a fixed amount of money.
• You get a fixed interest rate, a fixed monthly payment, and a fixed repayment period.
• Most personal loans are unsecured, but it is possible to get a secured loan.

How can a personal loan be used?

While you can take out a personal loan for any reason (or no reason at all), these loans are popular for consumers who need to borrow money for a specific reason. Let's say you want to remodel your kitchen but don't have the $30,000 the project requires or enough home equity to qualify for a home equity loan or home equity line of credit (HELOC). In that case, a personal loan could offer the money you need for your project provided your credit was good enough to qualify.

Personal loans are also popular to consolidate debt, and it's easy to see why. Imagine you're a consumer with high-interest credit card debt that's sucking your budget dry every month. A personal loan could help you consolidate that debt at a lower interest rate while securing a predictable monthly payment and a set payoff date that doesn't change.

Here's an example of how this could work: Say you have $10,000 in credit card debt with the average credit card APR of 17%. If you paid $250 each month, you would pay a total of $14,862 for 60 months (including principal and interest) before your balance was paid off. If you were able to consolidate that $10,000 balance at 5% APR and make the same $250 monthly payment, however, you could become debt-free in 44 months for a total cost of $10,962.

See our guide to the best debt consolidation loans »

Other reasons consumers get personal loans are nearly limitless, but can include:

• Borrowing money for a car
• Paying for higher education
• Paying for important home repairs
• Covering surprise bills and expenses

How to find the right personal loan

When it comes to shopping for a personal loan, you are better off comparing several lenders in terms of their rates, fees, and fine print. You'll obviously want to choose a loan with the lowest interest rate you can qualify for, but fees matter, too.

You can prequalify for a personal loan with many lenders before you submit an application. This allows you to see the rates and terms they're likely to offer you before they do a hard credit inquiry, which is likely to result in a slight dip in your credit score for a short time. 

Some personal loan companies charge an origination fee that can range from 1% to 8% of your loan amount, along with application fees and other fees. However, the highly competitive nature of the personal loans business means that many personal loans come free of fees for consumers who qualify.

It's important to take into account fees associated with a personal loan, to make sure it doesn't make the total cost of your debt higher in the end. Your best bet is shopping around with several lenders to find an option that makes sense for your budget and your needs.

As you compare personal loan companies, you'll want to look for:

• A lender that offers competitive interest rates
• No fees or minimal fees
• A monthly payment and loan term you can afford

Also consider how quickly you need money and take a look at quick personal loan options if you need it right away.

How can you qualify for a personal loan?

While some companies will lend you money with a credit score in the 500's, you may need to put down collateral to qualify. At the very least, you'll pay a much higher interest rate for a personal loan.

Most lenders list a minimum credit score to qualify on their website, with many drawing the line at 670 or 680. With a credit score below what is considered "very good credit," or 740, however, you will likely pay a higher interest rate.

In addition to checking your credit score, most personal loan requirements include proof of employment and your ability to repay the debt. Lenders will also check your debt-to-income ratio to make sure you haven't borrowed more than you can feasibly pay back.

If your credit isn't great, you can takes steps to improve your credit score before you apply to get a loan with the best possible rates and terms. Like other financial products, compare offers from many lenders before making a decision.

How personal loans work FAQs

How do personal loan payments work?

Personal loans are installment loans. That means you receive a lump-sum payment of cash, which you then pay back, with interest, over a fixed period of time. With a fixed-interest personal loan, your monthly payment will always be the same.

What are the risks of a personal loan?

As with any debt, taking out a personal loan comes with the risk that you won't be able to repay it on time, which could lead to extra fees and harm your credit score. 

Do you get money right away from personal loan?

Many personal loan lenders can approve your application and fund your loan either the same day or the next business day.

What is a personal loan and how does it work?

A personal loan is an installment loan that typically comes with a fixed interest rate. That means you receive a lum-sum payment of cash and you make monthly payments of equal amounts over a set period of time until you've paid off the loan and the interest.