- Personal loans provide lump-sum financing, typically with fixed repayment terms and interest rates.
- Common uses include debt consolidation, home improvements, major purchases, and medical or emergency expenses.
- Approval depends on factors such as credit score, credit history, and debt-to-income ratio. Those who cannot get approved may consider secured or cosigned loans.
- Personal loans generally cannot be used for purposes such as investments, student loan debt, down payments, or business expenses.
- Checking your credit report, pre-qualifying, and consulting with a financial advisor may help you secure favorable loan terms.
Personal loans can be used to fund a range of plans and projects. Learn more about when to consider a personal loan to meet your financing needs.
Perhaps you're trying to realize a dream you've been working toward for years, or your milestone moment is approaching and it's time to start planning. Or, maybe your life has recently changed, and your financial obligations have evolved with it. Whatever the reason, if you need to access money for personal expenses — whether planned or otherwise — you might consider a personal loan.
This type of financing can help you borrow the money you need for multiple uses, including consolidating high-interest debt. Personal loans can also be used to finance expenses for which you may not have enough cash on hand — or to avoid dipping into your savings.
Before you decide whether to pursue a personal loan, it's important to understand the basics of this type of loan. To help you decide, here is an overview of personal loans.
What are Personal Loans and How Do They Work?
Personal loans typically come in the form of lump-sum financing, which means you receive the entire amount of the loan (the principal) all at once from a lender. The lender issues terms with your loan, which dictate your repayment timeline, the interest rate you'll pay on top of the principal, and any fees, such as origination fees, to get the loan. Importantly, the higher the interest rate, the more the loan will end up costing you when you complete repayment.
Loan terms vary among lenders. This depends on variables such as the size of the loan and the borrower's credit history. Generally, the stronger an applicant's credit, the more favorable the loan terms will be. This means the loan may be less expensive overall.
Personal loans are generally unsecured, which means you don't have to put up collateral to get the loan. Some lenders may offer co-signed personal loans, in which an applicant with strong credit helps guarantee the loan since that person will be responsible for repaying the loan if the borrower does not. Having a cosigner may also make it easier to qualify for financing in some cases.
Understanding your lender and planning accordingly may help increase the chance of your loan approval. The more you know about a potential lender — for instance, what kinds of loans they offer, what benefits are available (e.g., discounts, automated payments), and if you need to have an existing relationship with them in order to qualify — the less time you'll need to research the details when you need the money. Having a sense of what kind of lender you're looking to work with and their process for evaluating loan applicants can help set you in the right direction.
Do You Have To Explain How You Will Use a Personal Loan?
When applying for a personal loan, many lenders will request that you specify the loan purpose. Some lenders may offer loans for specific purposes with restrictions.
Common Uses for Personal Loans
Personal loans are popular because they help many people address many kinds of financial needs. Here are common uses for this type of financing.
Debt Consolidation
Some people use personal loans for debt consolidation. Debt consolidation enables you to combine multiple higher-interest debts into one monthly payment with a fixed interest rate. For instance, leveraging a personal loan to pay off high-interest credit cards may help you pay off debt faster and save money in the long run since personal loans often have lower interest rates compared to credit cards.
Wedding and Honeymoon Expenses
Some people choose to use personal loans to fund wedding and honeymoon expenses instead of using personal savings to pay for them. Since personal financing is flexible, you can use the loan to pay for all or just a portion of your celebration expenses, depending on your preference.
Home Improvement
If you need to pay for home improvements, a personal loan can be a good resource. A loan for this purpose can cover improvements such as interior and exterior renovations and can also help borrowers pay for unexpected repairs.
Travel Expenses
If you are planning a big trip, you may want to use a personal loan for travel expenses. The loan funds can cover parts of your trip, including transportation, lodging, food and drink, entertainment, and attractions. You can also keep some of the financing on hand for extra cash while traveling or leave some aside for any unexpected expenses that may arise during your travels.
Moving Expenses
You can also use a personal loan to fund moving expenses. It can be expensive to move to a new home. Expenses may include moving supplies, transport, security deposits, and storage. A personal loan can also help pay for ways to personalize your new home with new furniture, decor, curtains, or shutters.
Medical Expenses
Unexpected healthcare costs can create a significant financial burden. Personal loans for medical expenses can help cover costs such as hospital bills, outpatient treatments, in vitro fertilization (IVF), or elective procedures. By spreading payments over time, this financing option may offer relief from large, immediate expenses that are difficult to manage.
Emergency Expenses
From a broken appliance to a necessary car repair, unexpected expenses can derail your budget. Using personal loans to cover emergency expenses can help you handle these situations quickly without depleting savings. With predictable monthly payments, personal loans offer a structured way to cover costs, providing flexibility during challenging times.
Other Major Purchases
You may find you need financing for any number of major purchases that arise, both planned and unexpected. Since personal loans can cover lots of different expenses — for example, a new computer, a home security system, or exercise equipment — you may find this extra money is the right solution for you if you're considering a purchase that costs more than you'd like to fund from your savings.
What Can't Personal Loans Be Used For?
A major upside of personal loans is that they're generally flexible and enable you to finance a range of expenses. However, most lenders have certain loan purpose restrictions and will not offer a personal loan when the funds are to be used for investing, down payments, certain educational expenses, and business expenses. You'll want to check in with your lender specifically to find out if they have any other specific guidelines or have other options for financing such expenses.
When to Avoid Using a Personal Loan
While personal loans are powerful tools in the right circumstances, there are some scenarios where they may not be appropriate. Consider avoiding a personal loan in the following situations:
- For long-term investments: Personal loans often have higher interest rates than other financing options.
- If the loan adds financial strain: If your current debt-to-income ratio is already high, taking on additional debt could make it harder to meet your financial obligations.
- When other financing is more suitable: You cannot use personal loans for certain expenses, such as buying a car or financing education.
- To fund nonessential luxuries: Financing nonessential purchases, such as luxury goods or vacations beyond your means, with a personal loan, can increase financial stress and make it harder to meet other financial obligations.
- When you lack a clear repayment plan: If you’re unsure how you’ll repay the loan within the agreed terms, taking on the debt could lead to late payments, fees, and damage to your credit score.
How Do You Get a Personal Loan?
There are several criteria lenders use to evaluate applicants for personal loans. They may include:
- Credit score: Your credit score provides a baseline for lenders to understand your past responsibility with credit, such as credit cards, auto and home loans, etc. There is no hard-and-fast rule for the minimum credit score you need, as this will vary among lenders. However, the higher your score and better your financial standing, the more likely you are to be approved and the more likely you may be to get better loan terms.
- Credit history: Lenders will evaluate your responsibility with past credit, including whether you make payments in full and on time, how many credit products you have open, etc. They will also look at how much credit history you have established.
- Credit ratios: Lenders may look at your credit utilization ratio, which is how much credit you are using versus how much credit you have available. The lower your credit utilization ratio, the better. They also look at your debt-to-income ratio, which is all your monthly debt payments divided by your gross monthly income. These numbers can help lenders see how well you may be able to handle additional debt.
Lenders may also evaluate personal loan applicants based on other factors, such as your existing relationship with the financial institution. Many lenders may require applicants to have an existing account with them or to have held an account with them in the past to be eligible for a personal loan.
Additionally, different lenders will have different methods to decide whether an applicant is eligible for a personal loan.
If you want to speed up your approval timeline, find the most favorable terms, and have a sense of the amount of money you may be able to borrow, there are a few things you can do. First, it can be helpful to check your credit report in advance of applying for a personal loan, to ensure accuracy or work with the bureau to fix any errors. Some lenders may enable you to pre-qualify for a personal loan, so you can see what your loan terms may potentially be and compare offers. Pre-qualification involves a soft credit check, and it will not impact your credit score.
Additionally, a financial advisor may help you navigate current lending conditions and consider all your options.
Can You Return a Personal Loan If You Don't Use It?
Since many personal loans are lump-sum loans, you can't return the money once you receive the funds. You are required to repay the loan within the repayment period whether or not you use the funds. You can repay the loan immediately or any time prior to the end of the repayment term; however, you are responsible for any interest that accrues during the period of time you have an outstanding loan balance.
If the lender charges a pre-payment penalty, you will also be responsible for paying that fee should you pay the loan off early. Some banks, including PNC Bank, do not charge prepayment penalties, so it's important to review your loan agreement.
Is a Personal Loan Right for Me?
Personal loans may be a good solution for certain types of purchases, as well as consolidating debt. You can use personal loans to take care of both planned purchases and unexpected expenses and do so with clear terms around repayment. This can be a big help when planning a healthy financial future.
Many people decide to apply for a personal loan instead of dipping into their cash reserves, to make sure they still have a buffer in their savings. This type of financing may also be a good option to consider instead of charging expenses with a credit card, since credit card interest rates are often higher than personal loan interest rates.
Final Thoughts
Personal loans are popular for a reason: they're generally flexible as to how they're used and offer a fixed repayment plan. Many people find personal loans useful to consolidate high-interest debt or finance major purchases, whether they are for milestone moments or unexpected expenses. Before submitting an application to a lender, it may help to evaluate your credit health with a financial advisor and find out if a personal loan is right for you. That way, you can plan your spending in the way that's best for you and your financial future.
