What Is a Personal Loan and How Can You Get One?

Personal loans are the Swiss Army knives of the financial world—versatile tools that can help you tackle all sorts of life's small (and not-so-small) challenges. Whether you're looking to consolidate debt, fund a home renovation or cover unexpected medical expenses, a personal loan might be the solution you need.

But like any tool, a personal loan works best when used properly. Here's what you need to know before taking out a personal loan to ensure it meets your needs and helps you achieve your goals.

What Are Personal Loans?

A personal loan is money you borrow—usually from a bank, credit union or online lender—that you agree to pay back on a set schedule at a fixed interest rate.

Secured vs. unsecured personal loans

There are two main types of personal loans:

• Secured loans: These loans require you to back up the loan with collateral, such as a car or cash in a savings or CD account. Since the lender has something to fall back on if you default on your payments, secured loans often have lower interest rates.
• Unsecured loans: These loans don't require any collateral. Lenders approve unsecured loans based on your creditworthiness, which is a fancy way of saying they look at your credit score, income and other financial factors to determine whether you're a good bet. Because unsecured loans are riskier for lenders, they tend to have higher interest rates.

Most personal loans are unsecured and range from $1,000 to $100,000, with repayment terms between 12 and 60 months. Shorter-term loans typically have lower interest rates than longer-term loans, but their monthly payments generally are higher. The interest rate you get also depends on the lender you choose, your financial situation and credit rating. The better your financial health, the better rate you're likely to get.

Reasons To Consider Applying For a Loan

Here are some of the most common reasons borrowers take out personal loans.

Debt consolidation

Struggling to keep track of multiple credit card or loan payments? A personal loan can help you streamline your debt by consolidating it into a single, fixed monthly payment, often at a lower interest rate.

Home renovations

Whether you're adding a new kitchen, finishing the basement or giving your bathroom a much-needed facelift, personal loans can be a great option for home improvement projects. They allow you to make the necessary upgrades without tapping into your home equity or taking out a second mortgage.

Medical expenses

No one plans to get sick, but medical bills can add up fast when you're ill. If your health insurance doesn't cover everything, a personal loan can help bridge the gap and spread the cost of care over time.

Large purchases

Planning a dream wedding, refurnishing your home or taking the vacation of a lifetime? Personal loans offer a way to finance large purchases without relying on high-interest credit cards. Just keep in mind that paying off that loan could last longer than your vacation memories, so think carefully before borrowing.

Emergency expenses

Life is full of surprises—and not always the good kind. A personal loan can be a lifesaver when you're faced with sudden car repairs, home emergencies or other unexpected costs, giving you breathing room to get back on your feet.

How To Get a Personal Loan

Getting a personal loan is a fairly straightforward process, but there are a few key steps you'll want to follow:

1. Check your credit score. Before you apply, take a peek at your credit report. Most lenders base their decision largely on your credit score, so it's important to know where you stand and address any errors or issues.
2. Gather required documents. Expect to provide proof of identity, income and employment, as well as information about your existing debt. Lenders want to see that you have the means to make your loan payments on time.
3. Compare lenders. Don't just jump on the first offer you see. Shop around and compare interest rates, repayment terms and fees from different lenders.
4. Submit your application. Once you've found the right lender, it's time to submit your application (most can be done online). At that point, lenders will review your credit score, income and overall financial health to decide whether to approve your loan.
5. Review the offer. If you're approved, carefully review the terms. Make sure you understand the interest rate, monthly payments and repayment timeline before signing on the dotted line. Also, be sure to read the fine print and understand all the fees, penalties and other terms of your loan agreement. A little due diligence can go a long way in ensuring you get the best deal.
6. Receive funds. Once you agree to the loan terms, the lender will transfer the funds to your account, often within a few days.

Pros and Cons of Personal Loans

Before you sign the loan agreement, be sure to weigh the pros and cons.

Pros

• Fixed interest rates. Most personal loans have fixed interest rates, meaning your monthly payments won't fluctuate. This can make budgeting easier.
• Fixed repayment terms. Knowing exactly when your loan will be paid off is helpful for long-term financial planning.
• Consolidation opportunity. A personal loan can simplify your financial life by consolidating multiple debts into one easy payment.

Cons

• Fees and penalties. Some lenders charge origination fees, which are up-front costs for processing the loan, or prepayment penalties if you pay off the loan early.
• Potential for high interest rates. If your credit score isn't in great shape, you may face higher interest rates, making the loan more expensive than you anticipated.
• Impact on credit score. Taking out a personal loan can ding your credit score temporarily, but consistent, on-time payments will likely boost it over time.

Alternatives to Personal Loans

If a personal loan doesn't quite fit the bill, there are a few other options worth exploring:

• Credit cards: For smaller, more immediate expenses, a credit card with a 0% introductory APR period or a low ongoing interest rate could be a better fit.
• Home equity loans/lines of credit: If you own your home and need a large sum of money, borrowing against your home's equity might offer better interest rates than a personal loan.
• Borrowing from friends or family: While potentially awkward, borrowing from loved ones can be an option if you're in a bind. Just be sure to set clear terms to avoid misunderstandings.
• Payday loans: In most cases, payday loans should be your absolute last resort. They come with sky-high interest rates and fees that can trap you in a cycle of debt.

Be a Smart Borrower

Personal loans can be a great financial tool, but they're not for every person or situation. If you're considering taking out a personal loan, weigh the pros and cons, explore alternatives, shop around and borrow only what you can comfortably afford to repay. Remember, good credit management is an important part of any loan decision. Learn more about how credit scores can affect future financial goals.

This article is part of Synchrony Bank's Personal Finance Series: Level 101. View all topics in the series here.