How Do Personal Loans Work?

A personal loan works by taking out a lump sum upfront from a lender and paying it back in monthly installments over a specific length of time, usually two to seven years.

Most personal loans are unsecured, meaning you don't have to put up any collateral, like your house or your car, to back and receive funding.

Key Takeaways

• A personal loan is a lump-sum installment loan. You borrow a set amount — most often $1,000 to $50,000, and up to $100,000 for strong credit — and repay it in fixed monthly payments over two to seven years.

• How personal loans work comes down to APR. Your annual percentage rate bundles the interest rate plus fees like origination charges, so it reflects the true cost of borrowing — and it's driven largely by your credit.

• Most personal loans are unsecured. You don't pledge collateral like a car or home, so approval leans on your credit score, income and debt-to-income ratio rather than an asset.

• Credit sets your rate and your options. A score of 670 or higher generally unlocks competitive APRs, while lower scores may see rates above 30% or fewer choices; many lenders set a minimum around 580.

• Lenders weigh income and DTI, too. A steady income and a debt-to-income ratio of about 36% or lower improve your odds of approval and better terms.

• Funding is usually fast. After approval you typically receive the money in one to seven business days, and some online lenders offer same-day or next-day funding.

Summary generated by AI, verified by MoneyLion editors

MoneyLion offers a service to help you find personal loan offers based on the info you provide, you can get matched with offers for up to $100,000 from our top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you.

How Personal Loans Work

Step-by-Step of the Personal Loan Process

Here are the steps you generally have to take to get and repay a personal loan.

1. Check your credit, debt and income.

2. Assess your budget to estimate an affordable monthly payment.

3. Select your loan type.

4. Research and compare offers from suitable lenders.

5. Apply for a strong offer you can comfortably repay.

6. Provide your income and credit documentation.

7. Once approved, confirm the monthly payment, rates and fees fit within your budget.

8. Accept and sign a formal loan agreement.

9. Receive the money in a lump sum, usually via direct deposit.

10. Set-up auto-pay so you don’t miss your first monthly payment.

11. Continue making monthly payments until you repay the loan in full.

What They're Used For

Personal loans are commonly used for debt consolidation, home improvements, other large purchases, like appliances, furniture or fertility treatments, and emergency expenses, like urgent car repairs, medical bills and relocation costs. 

When lenders extend personal loans for these and other purposes, they charge interest based on your quoted annual percentage rate (APR), borrowing amount and length (or term) of the loan. This interest and other fees make up their loan profits. To ensure they make money, lenders assess your creditworthiness to determine default risk, whether they’re willing to lend and how much they’ll charge for financing. 

A personal loan is a good choice if you need a lump sum fast, have good or excellent credit and can make your monthly payments. You shouldn't take out a personal loan if you can pay cash or qualify for cheaper financing, can't afford the monthly payments or don't have a clear need for the funds.

Types of Personal Loans

The main types of personal loans include:

There are other options you can try instead, such as:

• Debt consolidation: Some personal loans are used specifically to consolidate multiple high-interest debts, like credit card balances, into a single monthly payment, ideally at a lower APR. 

• Joint personal loans: Some lenders allow co-signers or co-borrowers so applicants can more readily reach income and credit requirements and ultimately repay their personal loans as agreed.

• Personal loans for students: Students can get a personal loan through a bank, credit union and even some online financial institutions, though, you might find the terms aren't as cost-effective as federal funding, grants and scholarships and even student loans.

Researching and comparing offers for the type of personal loan you need can simplify your search, increase approval odds and help you find more affordable rates, terms or monthly payments. If you're considering having more than one personal loan, it's best to keep your credit and financial health in good shape.

How To Qualify for a Personal Loan 

To qualify for a personal loan, you'll need to meet a lender’s specific credit, income and general eligibility requirements. For instance, most lenders require you to be at least 18 years old, have a valid Social Security number and reside in a state where they operate. 

Credit Score Requirements for a Personal Loan

This chart illustrates how different credit profiles can impact your ability to get approved for a personal loan with affordable terms and conditions. 

Source: MyFico.com

While all lenders have their own underwriting criteria, generally speaking, the higher your credit score, the more loan options you’ll have and the better your rates and terms are likely to be. On the flip side, the lower your credit, the more limited and pricier your borrowing options become. 

A high income and lower existing debt levels can improve your odds of meeting a lender's approval criteria. 

MoneyLion's personal loan marketplace can help you find and compare offers from lenders that work with your specific credit and financial profile. 

How To Apply for a Personal Loan 

While there may be some slight variation across lenders, typically, you’ll follow these steps to apply for a personal loan:

1. Prequalify with lenders who cater to your credit profile.

2. Compare offers, including rates, monthly payments and total borrowing costs. 

3. Gather documentation, like identification, W-2s and pay stubs.

4. Formally apply with your preferred lender.

5. Agree to a hard credit check so the lender can fully underwrite the loan.  

6. Receive a formal loan offer and contract.

7. Review your loan amount, APR, term and monthly payment. 

8. Confirm whether the lender charges origination fees and prepayment penalties.

9. Sign this agreement if the terms are agreeable. 

10. Receive your lump-sum funding, usually in one to seven business days. 

Once you receive a personal loan, it's important to make all monthly payments on time. Otherwise, you may incur late payment or other fees, enter collections or damage your credit. 

👉 Up Next: Learn more about smart personal loan repayment strategies. 

FAQ

Are there prepayment penalties on personal loans?

There may be prepayment penalties for paying off personal loans early. However, they’ve become less common in recent years, and, in fact, are not charged by most top lenders. You can determine whether a lender charges a prepayment penalty by reading your full loan agreement or asking directly.  

Do personal loans have origination fees?

Many personal loans carry origination fees of usually 1% to 10% of your loan amount. They cover the costs of processing and underwriting your application and are usually deducted from your funds after approval, but before you receive them. A few top lenders, including LightStream and Discover, charge no origination fees.  

How long does personal loan approval take?

Most personal loan approvals take between one and seven business days, though the process may take longer, depending on your chosen lender, credit profile, employment or income type and other factors.  

What's the difference between a fixed-rate and variable-rate personal loan?

A fixed-rate personal loan has a fixed interest rate that remains the same throughout the loan term. A variable-rate personal loan carries an interest rate that can change in line with a benchmark index, such as the prime rate. Fixed-rate personal loans have set monthly payments. Variable-rate personal loan monthly payments may change periodically alongside interest rate fluctuations.

How do I prequalify for a personal loan?

You can prequalify for a personal loan by visiting a lender’s website or a loan marketplace and submitting a rate request through their prequalification form. You may need to submit some personal information, like your name, address and the last four-digits of your Social Security number to receive prequalified offers. Prequalification lets you see estimated rates and approval odds without formally applying and incurring a hard credit inquiry.  

Does prequalifying affect my credit score?

Prequalifying for a personal loan does not affect your credit score as it involves a soft inquiry. Soft inquiries are not visible to lenders on your credit reports and aren’t used to calculate major credit scores.  

Key Terms

• Personal loan: A general-purpose loan you receive as a lump sum and repay in fixed monthly installments over a set term, usually two to seven years. Most are unsecured.

• Annual percentage rate (APR): The yearly cost of borrowing expressed as a percentage, including the interest rate plus lender fees such as origination charges — the most accurate figure for comparing offers.

• Interest rate: The annual cost to borrow money as a percentage of the principal, not including fees. It's always lower than the loan's APR.

• Secured loan: A loan backed by collateral — such as a car or savings account — that the lender can claim if you default. It often carries lower rates and higher limits.

• Unsecured loan: A loan that requires no collateral; approval and rates are based on your creditworthiness, income and overall financial health.

• Origination fee: A one-time upfront charge, typically 1% to 10% of the loan amount, that covers processing and is usually deducted from your funds before you receive them.

• Debt-to-income ratio (DTI): Your total monthly debt payments divided by your gross monthly income; most personal loan lenders prefer a DTI of about 36% or lower.

• Prequalification: A preliminary review using a soft credit check that shows estimated rates without affecting your score — a low-risk way to compare offers before you formally apply.

Sources

• Consumer Financial Protection Bureau: What Is a Credit Inquiry?

• myFICO: Do Credit Inquiries Lower Your FICO Score?

• FDIC: What Is the Difference Between a Fixed Rate and a Variable Rate?

• myFICO: Understanding FICO Scores (PDF)

Summary generated by AI, verified by MoneyLion editors