In short, a personal loan is a loan that can be spent on whatever you want. Each loan is a lump sum lent to a borrower with the expectation it will be repaid in fixed payments over one to five years.
Personal loans are some of the custom loan options available. Consumers can seek secured or unsecured personal loans from a bank, credit union, or personal lender, and the loan itself can be used for financing cars, housing costs, education, debt consolidation, or any other major expense.
As you can see, when it comes to a personal loan, there are a lot of variables. So, before you decide which personal loan is best for you (or if you should even choose a personal loan over other types of loans), ask yourself a few questions:
- What kind of debt am I trying to cover?
- Should I choose a bank, credit union, or private lender for my personal loan?
- How can I get the best personal loan rate?
- What questions do I need to ask my lender?
Before we begin, here are some terms you should be familiar with.
Personal loan terms and definitions
- Annual Percentage Rate (APR): APR refers to the additional costs — both in interest and fees — borrowers must repay in addition to the principal of their loan. APRs are always expressed as a percentage, and determined by credit history, the length of the loan, the amount borrowed, and debt-to-income ratio.
- Debt-to-Income Ratio (DTI): This is how much you owe, versus how much you currently make. To find your DTI, add up your total monthly payments and divide that number by your gross monthly income. Lower ratios (up to 35%) signal to lenders that you’re fiscally responsible, and thus a good investment. Maintaining a low DTI is one of the keys to earning a lower APR.
- Fixed vs. Variable Rate: These terms refer to the stability of interest rates over the course of a loan.
- Fixed interest rates do not change throughout a loan’s duration. If your rate is 5%, it will always be 5%.
- Variable interest rates can fluctuate according to a number of factors, such as the U.S. Prime Rate index or paying down your principal. For example, your loan could start with a 3% variable interest rate, then increase to 7% if the U.S. Prime Rate index jumps.
- Prepayment Fees: Prepayment, or exit fees, are extra fees charged when you fully repay loans within a certain time period (such as paying off early). These are usually associated with mortgages, but could come with personal loans as well.
- Prequalification: During prequalification, lenders examine your credit history, and determine whether or not you’d qualify for a loan. Prequalification is very casual — you won’t receive official offers, and the process can be done remotely with nothing more than a soft credit pull.
- Secured vs. Unsecured Loans: These terms refer to any and all collateral you might be expected to put up as part of your loan.
- An unsecured loan isn’t protected by collateral (such as your car or home which could be forfeited if you default).
- A secured loan is protected by collateral as well as an agreement that the lender can take possession of a specific piece of property if you fail to make payments.
- In general, secured loans have higher rates and more terms; however, in some cases (such as high DTI or low credit score), you may need a secured loan in order to rebuild your credit.
- Soft vs. Hard Credit Pull: Also known as “credit inquiries” or “credit checks,” a credit pull is when any organization checks your credit report.
- Soft credit pulls are unofficial and can be initiated by potential lenders, financial institutions, or even by the individual themselves. They do not affect your credit score.
- Hard credit pulls are official credit checks made by institutions that are considering whether or not to lend you money. As a result, you appear to be taking on more debt, and thus your credit score may decrease.
Is a personal loan right for me?
A personal loan is just that: personal. Once you receive a personal loan, you’re free to spend it on whatever you want, so long as you’re able to pay it back via monthly payments for a specified period of time.
But as a result, personal loan lenders often compete against other types of loans. For example, a homeowner that’s looking to refinance their property can choose between a personal loan, a home equity loan, and a home equity line of credit (HELOC).
Simply put, personal loans aren’t always the best option. We’ve compared personal loans against other common types of loans to help you determine which loan works the best for you.
What’s my optimal loan?
Personal loans for debt consolidation
Personal loans are most commonly used for debt consolidation. Individuals with multiple sources of debt often have varying payments each month. Their existing loans may come with a high APR, disreputable lenders, steep monthly payments, or other unfavorable terms.
Borrowers in this situation have the option of taking out a personal loan to pay off all existing sources of debt, and instead simply pay off a single loan with fixed monthly payments. It’s an attractive option for many borrowers, and can actually cause a jump in credit score.
This is the ideal option for anyone with a lower credit score, higher DTI, and multiple sources of debt — in fact, it may be the only option available. You may have to take out a secured loan with a higher APR, but so long as you make monthly payments consistently and on time, you’ll be able to put your debt to rest.
Personal loans vs. balance transfers
|Criteria||Personal Loan||Balance Transfer|
|Average APR||10% – 28%||11.99% – 24.99%|
|Loan / transfer duration||12 – 60months||0% intro APR for 9 – 18 months, regular interest after|
|Additional fees||0% – 10% loan origination fees||Up to 3% balance transfer fees|
|Ideal credit score||Poor, Fair, Good, Excellent||Good, Excellent|
|Best for||Debt consolidation||Credit Card debt|
|Type of debt||Fixed installment||Revolving|
If you have good to excellent credit, and you’re confident you’ll be able to pay off your debts entirely within nine to 18 months, you might want to consider a balance transfer instead of a personal loan.
The best balance transfer credit cards aren’t like traditional credit cards. They’re not meant to be used to cover day-to-day purchases. Instead, they’re meant to be used for debt consolidation. Any existing credit card debt can be transferred to your balance transfer card (with up to 3% transfer fee), and paid off without any APR for up to 18 months.
If you choose to take out a balance transfer credit card, be very careful about paying off your balance in full within the introductory 0% APR period. Otherwise, you’ll be hit with a considerable APR — averaging between 12% and 25%.
Personal loans vs. home equity loans
|Criteria||Personal Loan||Home Equity Loan|
|Average APR||10% – 28%||4% – 6%|
|Loan duration||1 – 5 years||10 – 15 years|
|Additional fees||0% – 10% loan origination fees||2% – 5% in closing costs|
|Ideal credit score||Poor, Fair, Good, Excellent||Fair, Good, Excellent|
|Best for||Debt consolidation||Refinancing or remodeling home|
|Type of debt||Fixed installment||Fixed installment|
Home equity loans are lump sum, fixed-installment loans that borrow against a property’s equity. A homeowner’s equity is determined by the property’s total value, minus the debt still owed on said property. (Home equity loans are also commonly known as “second mortgages.”)
The best home equity loans are one of two loan options (along with a HELOC) designed to refinance a property.
Lenders require potential borrowers to own at least 20% to 25% equity in their home, have at least a fair credit score, and have a consistent record of employment with a steady stream of income.
In addition, home equity loans are often secured by the home itself. While that might give potential borrowers more favorable rates, if it’s a source of concern you may want to consider taking out a personal loan instead.
Personal loans vs. home equity lines of credit (HELOC)
|Criteria||Personal Loan||Home Equity Line of Credit (HELOC)|
|Average APR||10% – 28%||3% – 6% variable|
|Loan / transfer duration||12 – 60 months||5 – 10 year draw period, 10 – 25 year payment period|
|Additional fees||0% – 10% loan origination fees||$50 – $100 yearly maintenance fees, average 2 – 5% closing costs|
|Types of credit accepted||Poor, Fair, Good, Excellent||Good, Excellent|
|Best for||Debt consolidation||Remodeling home|
|Type of debt||Fixed installment||Revolving|
Both home equity loans and HELOCs provide loans by borrowing against the equity of your property. But while a home equity loan is a lump sum with a fixed repayment period, HELOCs operate as revolving lines of credit, much like a credit card does. Here’s how it works:
When a homeowner signs up for a HELOC, they’re allowed to draw money out of their home’s equity for 5 to 10 years. This is known as the HELOC “draw period.” During this time, homeowners can use the money for a variety of reasons, same as a personal loan, up to a certain amount.
During the draw period, borrowers are allowed to make interest-only payments. They won’t be able to repay the principal, however, until the repayment period.
Once the draw period concludes, borrowers enter a repayment period that can last anywhere between 10 to 25 years. During this time, they’re expected to repay all of the money they borrowed (principal), as well as any remaining interest.
What makes home equity line of credit loans distinct is their variable APR, meaning that borrowers take a gamble on what the interest rate might be when payment comes due. HELOCs work best for homeowners with excellent credit that are using multiple organizations for home renovation and have bills with different costs coming due at different times. For everyone else, personal loans or home equity loans may be a better choice.
Personal loans vs. auto loans
|Criteria||Personal Loan||Auto Loan|
|Average APR||10% – 28%||0% – 10%|
|Loan / transfer duration||12 – 60 months||3 – 6 years|
|Additional fees||0% – 10% loan origination fees||Varies by state and dealer|
|Types of credit accepted||Poor, Fair, Good, Excellent||Bad, Poor, Fair, Good, Excellent|
|Best for||Debt consolidation||Financing a new or used car|
|Type of debt||Fixed installment||Fixed – simple or pre-computed interest|
Cars are a notoriously bad investment. New cars lose approximately 10% of their value the moment you drive them off the lot. So finding a favorable auto loan is important, to say the least.
When it comes to auto financing, you’re likely to be presented with an auto loan through your dealer. Dealers are well aware of how fast cars depreciate, so they’re willing to offer a lower APR to potential customers with better credit. But if your credit’s on the lower side, you’re likely to see higher interest rates.
In addition, auto loans come with two different types of interest — simple, and pre-computed interest. Simple interest acts like fixed interest meaning your monthly interest will remain fixed for the duration of the loan. Pre-computed interest is more variable, offering less interest on higher payments but increasing the percentage as the principal goes down.
If your credit score is on the higher side, and you’re able to afford a down payment of at least 20% of the car’s total, one of the best auto loans may offer more favorable terms. Otherwise, personal loans offer better financing, and can even be used as a negotiating tactic.
Personal loan vs. small business loan
|Criteria||Personal Loan||Small Business Loan (Standard 7a)|
|Average APR||10% – 28%||6.5% – 9% (Varies per loan)|
|Loan / transfer duration||12 – 60 months||7 – 25 years depending on industry|
|Additional fees||0% – 10% loan origination fees||0% – 3.5% (varies by size of loan)|
|Types of credit accepted||Fair, Good, Excellent||Fair, Good, Excellent|
|Best for||Credit card debt||Growing or starting a business|
|Type of debt||Fixed installment||Fixed or variable|
Note: There’s such a large variety of small business loans, that we don’t have the space to cover them here. We’ve chosen to focus on a Standard 7a loan for $20,000.
If you need financing in order to grow or start a business, then you’ve entered the world of small business loans. The best small business loans are unique from other types of loans, in the sense that they can offer both revolving and fixed capital.
In addition, small business loans are guaranteed by the U.S. Small Business Association (SBA). So if your business defaults, the SBA will cover a certain percentage of the remaining loan.
Business loan durations can vary from repayment within seven years, as in a Standard 7a small business loan, or more than seven years, as in a Standard 7b.
Proceeds can only be used to help finance your business and cannot be used to reimburse owners for any money they’ve already put in. Nor can they be used to refinance existing debt.
If you’re confident in your business and you need a considerable amount of capital, along with backing from and access to business experts, a small business loan will be the most helpful. For everything else, consider a personal loan.
Which personal loan lender is best for me?
When you’re shopping for a personal loan, you want to get the most favorable terms. Banks, credit unions, and online lenders all offer personal loans at competitive rates, but each gives borrowers a different experience.
Your decision should be based on your current financial status, the reason for your loan, and the financial institution you feel you’ll work the best with.
What type of lender works best for me?
Using a bank
- Variety of loan options
- Multiple brick-and-mortar locations
- Lower rates for good standing
- Higher interest rates
- Difficult for poorer credit
- Few unsecured loan options
Large financial institutions such as banks are still the most traditional way to get a private loan. And even though their reputation took a hit after the Great Recession, they’re still some of the most popular lenders in the nation.
Banks work best for anyone with fair to excellent credit, and they’re ideal for borrowers that already have an existing relationship with a financial institution. For example, if you’ve been banking with Wells Fargo for five years, you’re likely to find more favorable terms there than anywhere else.
Banks also have a variety of loan options — meaning that if you feel you’d rather pursue an auto or home equity loan instead of a personal loan, you’ll be able to deal with the same organization and still retain those favorable terms.
But banks are for-profit institutions run by shareholders, that do emphasize making money. As a result, interest rates are higher, and they want to be sure that all their borrowers are in good financial standing.
If you’re looking to use a personal loan to consolidate your debt, you may be better off with a credit union or online lender.
Using a credit union
- Lower interest rates
- Member-owned institutions
- Easier approval
- Fewer services
- Membership criteria
- Fewer loan options
If you’re looking to compare banks and credit unions, you’ll find a lot of similarities and a few key differences:
While banks are for-profit owned by investors, credit unions are non-profits owned and operated by members. And while banks are open to everyone, credit unions are limited to members that meet certain criteria (known as the “field of membership”).
Beyond that, banks and credit unions offer a lot of the same financial services: You’ll be able to take out personal loans, auto loans, home equity loans, etc. However, since credit unions are smaller institutions, they don’t offer as wide a variety of loans as banks do.
They do, however, offer lower rates and easier approval for those with poor to average credit. That makes credit unions one of the best options for anyone looking to rebuild their finances via debt consolidation. Just be sure to check the field of membership criteria first.
Using an online lender
- Easy approval
- Unsecured loans
- Can be predatory
- Higher APR
- High payday loan presence
Online lenders (sometimes known as peer-to-peer or “P2P” lenders) are at the cutting edge of financial tech. The best online personal loan lenders pair banks and other financial institutions that are looking to fund specific types of loans with borrowers looking to take out the same type of loan.
As a result, online lenders are the most customizable lenders in the marketplace. They also have the largest approval rate. If your credit score is on the lower side, you’re more likely to find a personal loan with an online lender than a bank. However, that’s a double-edged sword.
Online lenders are for-profits that make money off of their loans. As a result, the APR tends to be higher with many online lenders than it would be with a bank or credit union. In addition, there’s a number of illegitimate or predatory online lenders that are likely to sell your personal information.
Payday lenders also have a strong presence in the online lending space, so be wary of any lender that offers loans with no credit checks, short terms, and high fees.
The bottom line
Personal loans can be one of the most versatile financial services out there: You can use one to rebuild credit or finance a big purchase. But you need to be sure that a personal loan is your best option, and that you’re choosing the best lender. Once you’re sure about both, you’re all set!