The Basics of Personal Loans

November 20, 2023 Personal Loans
The Basics of Personal Loans

What is a personal loan?

Personal loans are a versatile way to borrow money from a credit union, bank, or online lender. Because they grant quick access to a lump sum of funds that gets deposited into your account, personal loans can be helpful in a variety of situations, such as financing a major purchase or consolidating debt.

After taking out a personal loan, you will typically be expected to repay it over time at a fixed interest rate. Depending on the type of personal loan and the lender, the loan terms and conditions can vary.

It can be daunting to navigate the world of personal loans. Knowing the different types of personal loans can help you make an informed financial decision and potentially avoid extra costs. In this article, we will give you an overview of the essentials you need to know about personal loans.

Types of personal loans

There are two major types of personal loans: secured and unsecured.

Secured personal loan: To get a secured personal loan, you’ll have to offer an asset that is worth some amount of value to the lender as collateral. The asset may be cash or physical (e.g. a car). If you fail to repay the money you owe and end up defaulting on the secured personal loan, the lender will gain that asset. Common examples are mortgages and auto loans.

Unsecured personal loan: Unsecured means you don’t have to put up any collateral. However, there are still consequences to defaulting on an unsecured personal loan. Your credit score can take a severe hit, affecting future costs dramatically. The lender may file a lawsuit against you to get back what they are owed.

Since mortgages and auto loans are so commonly used to finance houses and vehicles, the term personal loan tends to refer to unsecured loans. Other personal loan types include:

Specialized loans: Some companies offer personal loans to their clients and customers in order to help them more easily afford their products or services. This kind of financing may be found in home improvement stores, electronics stores, and more.

Credit-builder loans: These don’t extend a line of credit to you. Instead, you get the personal loan deposited into your savings account, allowing you to use it to pay your balance. The lender will report the payments you make to credit bureaus.


Terms and conditions for personal loans

While each personal loan’s terms and conditions will differ based on your credit history, chosen lender, and other factors, there are some common terms and conditions you should know.

Credit score requirements

Your credit history is represented by a three-digit number. It essentially tells lenders how risky it is to lend money to you.

Lenders often require borrowers to have a good credit score before they can get approved for a personal loan. A high credit score can help you qualify for better interest rates and terms. Making loan payments on time can help you build up a positive credit history.

For those with low credit, it can be challenging to qualify for a personal loan, but it’s definitely still possible to get a $5,000 loan even with bad credit. Having low credit does often mean you’ll have a higher interest rate—which brings us to our next common loan term.

As a rough guideline, here are the minimum credit score requirements for common loan amounts:

  • $1000 - 580
  • $5000 - 580+
  • $10,000 - 640+

Of course, some lenders are stricter whereas others are willing to grant loans to those with bad credit.

Interest rate

Borrowing money with interest means you will have to repay the lender more than you borrowed by a certain percentage (i.e. the interest rate).

Many lenders operate with fixed interest. This means that throughout the life of the personal loan, you will pay the same interest that you agreed to in the beginning.

Some lenders use variable interest, which fluctuates depending on certain factors and is influenced by the Federal Reserve prime rate.

The advantage of a fixed-interest loan is that it allows borrowers to set aside a fixed amount of money each month for repaying the loan. Many find this predictability valuable. Others prefer variable-interest loans, which may ensure a more accurate interest rate based on factors such as the current market conditions.


The annual percentage rate (APR) encapsulates all the annual fees you’ll spend after taking out a loan. It reflects the interest rate, broker fees, and anything else that affects your APR. Most loans come with a fixed APR, making repayment more predictable.

Loan amount

The loan amount is how much money you’re borrowing from the lender. You might hear the loan amount called the principal, which can also refer to how much money you still need to pay back to the lender.

Although everyone’s situation is different, borrowers are often advised to only take a loan amount that they really need.

Lenders typically have a minimum loan amount and a maximum loan amount they are willing to lend.

Hard and soft inquiries

An inquiry is a credit check, which determines your creditworthiness.

For personal loans, a soft credit check doesn’t impact your credit score. Lenders might look at your credit report to assess risk in advance of your applying for credit. Soft inquiries are invisible to other potential lenders who might review your credit reports.

On the other hand, a hard credit check typically results in a minor dip in your credit score. This is done after you’ve applied for the loan.

If you’re worried about the score decreasing your credit score too much and you need decent credit for other uses, you might feel hesitant to take out a personal loan. It’s good to know that in normal cases, credit scores tend to bounce back a few months after a hard inquiry.


How much are personal loan interest rates?

The interest rate you need to pay for a personal loan will depend on your credit score. If you have good credit, you can expect to pay less in interest over the life of the loan.

Your credit score is determined by numerous factors, such as your payment history, incurred debt, credit history, new inquiries, as well as types of credit.

How does loan tenure affect a personal loan?

Loan tenure is the period of time during which you are expected to make regular, fixed payments to the lender. You have to pay the final installment by the end of the tenure–otherwise, you may face various consequences.

A longer loan tenure usually means you need to pay less each month, but there is a higher total interest.

Many borrowers feel uncertain when it comes to their loan tenure. Loan repayments are a long-term commitment, and missing an installment due to being unable to meet the fixed payment amount can cause stress and extra expenses.

When picking loan tenure, it’s generally advisable to take into account the interest rate and amount to pay each month, which vary based on the tenure duration. A reasonable balance can help you better manage your debt and repayment schedule.

Repayment options for personal loans

The lender will outline your repayment options to you. It’s important to choose the one that aligns with your financial goals and budget. The common repayment options include:

Monthly Payments: The most common method of personal loan repayment. You can make either fixed monthly payments or variable monthly payments, depending on whether your personal loan operates on fixed interest or variable interest.

Balloon Payments: A balloon payment option means you’ll pay a large amount at the end of the loan period. This usually lowers your monthly installations.

Biweekly Payments: For those who want to pay off their loan more quickly, biweekly payments may be preferred.

Lump Sum Payments: Some lenders give you the option to make extra lump sum payments so that you can pay off the loan earlier.


Consequences for defaulting on a personal loan

Defaulting means that you’ve missed a payment installation. This usually means your payment is overdue by 90 days, but the exact default definition varies based on your lender’s policies. If your payment is only a few days late, don’t worry–this counts as a delinquent personal loan, and there is often a grace period of 10 days, followed by a late fee.
A personal loan payment installation needs to be 30 days past due before it can be reported to a credit bureau as a late payment. If your personal loan is in default, the following things may occur:

  • Your credit score can get damaged (up to 100 points)
  • The impact of the missed payment will remain on your credit report for up to seven years
  • It can be harder to qualify for credit in the future
  • Any co-applicants on your loan become obligated to cover it

Secured loans

The lender has the right to seize collateral that you pledged upon taking a personal loan. This may be cash assets, property, titles, or savings and investment accounts.

Unsecured loans

For unsecured loans, the lender or a debt collector might take you to court. As they file a lawsuit against you, they might seek to:

  • Place a lien (legal claim) on an asset you own (e.g. your car or house)
  • Garnish your wages

What should I do if I miss a personal loan monthly payment?

If you’re concerned about defaulting on your loan, it might be a good idea to contact your lender proactively to ask for help. They may offer you financial relief in the form of a temporary loan suspension or a deferment.

If you suspect your debt collector is harassing you, using deceptive or abusive practices, or breaking the law, you may wish to contact an attorney and/or file a complaint with the Consumer Financial Protection Bureau.

In cases where you’re being sued, seeking legal counsel with a lawyer is generally a good course of action to help you know your rights and handle the lawsuit. It’s important to know that if you fail to show up in court, the default judgment results in the judge automatically ruling in favor of the lender or debt collector.

Fees and charges

When you get a loan, you might need to pay various related expenses. Here are some of the common fees and charges you might need to pay.

  • Obligation Fee: Some lenders will charge an initial origination fee when you get a personal loan. This fee can climb quite high, often up to 10 percent of the loan amount.
  • Application Fee: To process your loan application, lenders may charge a few dollars or a small percentage of the loan amount.
  • Late Fee: You might be charged a late payment fee if you miss a payment.
  • Prepayment Penalty: Some lenders actually charge a fee if you pay your loan off early. Check with your lender to see whether they allow you to make lump sum payments to pay off your loan fast without facing this penalty.

Loan closure

Many people are surprised to discover that there is a formal process to close a personal loan, AKA the loan closure.

When finalizing your loan closure, you might need to sign some documents or visit your lender.

Personal loan FAQs

**Does taking out a personal loan hurt my credit score? **

Your credit score can take a brief hit if the lender makes a hard inquiry.

**How much do I need to pay for a personal loan? **

There are numerous fees and charges associated with taking out a personal loan, varying based on what lender you choose. Check with your lender to see your loan specifics.

How do I get a personal loan?

Requirements vary by lender. You generally need to get approved, which is made easier by having good credit and financial standing. If you’re struggling to get approved for a personal loan, a co-signer with good credit may be able to raise your chances.

**How do I know if a personal loan is right for me? **

There are alternatives to taking out a personal loan. For some people, it might be better to open a credit card, take out a home equity loan, or obtain money through a cash-out refinance. Be aware of your personal needs, budget, and alternatives before you get a personal loan.

About The Author

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Ru Chen

Content Writer

Ru Chen is a content writer with several years of experience in creating engaging and well-researched articles. She mostly writes about business, digital marketing, and law. In her free time, she can be found watching horror movies and playing board games with her partner in Brooklyn.

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