What Is a Personal Loan?

A personal loan is a lump sum of money borrowed from a bank, credit union or other lender that you agree to repay in fixed installments over a set period of time.

The main difference between personal loans and other types of borrowing is that they can generally be used for almost any purpose. In contrast, auto loans and mortgages are specifically designed to purchase vehicles and property.

Most personal loans are unsecured, meaning they are not backed by any collateral. However, some lenders offer secured personal loans, where you provide an asset that the lender can claim if you fail to repay the loan. These work similarly to secured auto loans and mortgages.

What makes up a personal loan?

A personal loan has three main components:

Loan Amount

Also known as the principal, this is the amount of money you borrow from the lender. Loan amounts can vary significantly, from a few hundred dollars to $100,000 or more depending on the lender and your credit profile.

APR

The Annual Percentage Rate represents the total cost of borrowing and is expressed as a yearly percentage of the loan amount. It includes the interest rate as well as unavoidable fees associated with the loan, such as origination fees.

Borrowers with excellent credit may qualify for APRs as low as 5%, while some high-cost lenders can charge significantly higher rates. Payday loans, for example, can carry APRs above 500%, although many personal loan lenders cap rates at 36% or lower.

Loan Term

This refers to the amount of time you have to repay the loan. Most personal loans require monthly payments, although some lenders serving higher-risk borrowers may offer biweekly or weekly repayment schedules.

Loan terms can range from as little as 6 months to as long as 84 months (7 years). A longer loan term can reduce your monthly payment, but it usually means paying more interest over the life of the loan.

With these ingredients, you can estimate the monthly payment, as well as the total cost of the loan. Try our free Payment Calculator to learn more.

What can I use a personal loan for?

Personal loans can generally be used for almost any purpose, although lenders often have some restrictions. Common exclusions include:

• Postsecondary education expenses (e.g. college tuition)
• Business or commercial purposes
• Purchasing stocks or other securities
• Gambling or illegal activities

Some of the most common uses for personal loans include:

Pay off credit cards: Personal loans often have lower APRs than credit cards. Using a personal loan to pay off credit card debt can reduce your interest costs and help you pay down your debt faster.

Consolidate debts: If you have multiple debts, you may be able to combine them into a single personal loan. Having one monthly payment can make managing your finances simpler and more predictable.

Home improvements: Whether you're renovating a kitchen, replacing a roof or making another major repair, a personal loan can help cover the upfront cost.

Large expenses: Personal loans can be useful for unexpected expenses, such as medical bills or major car repairs. Fixed monthly payments can make a large expense easier to manage compared to putting the cost on a credit card.

Summary

Personal loans can be a flexible way to borrow money because they can typically be used for a wide range of expenses. However, the cost of borrowing depends on factors like your loan amount, APR and repayment term.

Before taking out a personal loan, it's important to compare your options and make sure the monthly payments fit comfortably within your budget. A lower monthly payment may seem attractive, but extending the loan term can significantly increase the total interest you pay.

Used responsibly, personal loans can be a useful financial tool. However, they are still debt and should be approached with a clear understanding of the costs involved.