Bankrate's guide to choosing the right personal loan
What is a personal loan?
Personal loans are shorter-term loans consumers can receive from banks, credit unions or private lenders, such as online marketplace lenders and non-bank peer-to-peer lenders. The proceeds of the loan can be used for just about any purpose, such as paying off other debt, financing a kitchen renovation or paying for a wedding.
Borrowers receive a single lump sum which is repaid over a number of years. Most personal loans range from 24 months to 60 months. The typical personal loan is repaid in monthly installments similar to a car loan or home mortgage.
Personal loans are typically unsecured, which means they are not backed by collateral such as a car, house or other assets.
If you need cash fast, these loans are a good alternative because the approval process is fairly quick and you can also receive your lump sum sooner than obtaining a home equity line of credit.
Personal loan interest rates
The interest rate for a personal loan depends mostly on your credit score. Interest rates for personal loans currently range from 6 percent to 36 percent, depending on your credit score.
The average personal loan interest rate is 9.8 percent for “excellent” credit scores ranging from 720-850, 15 percent for credit scores of 690-719, 21.3 percent for credit scores of 630-689 and 28.2 percent for “poor” credit scores of 300-629.
“Like any loan, a borrower is usually qualified on the basis of credit, income and debt ratios,” says Greg McBride, CFA, chief financial analyst for Bankrate. “Some lenders are more lenient than others but will charge a substantially higher rate for borrowers deemed higher risk.”
Average Personal Loan Rates by Credit Rating
Reasons for personal loans
Some of the most common reasons people consider a personal loan are:
Pros of personal loans
- The convenience of receiving the money upfront in a lump sum
- You can get the money quickly, in as little as one day, depending on the lender
- They’re easier to apply for than mortgages or personal lines of credit
“For consumers with good credit, a personal loan can be had at a competitive rate with a quick turnaround,” says McBride.
If a consumer can’t afford to make much more than the minimum payments on a credit card, a personal loan could work out better for them financially because the entire debt would be paid off sooner and they’d pay less in interest, Triggs says. But that’s only if they can afford the single monthly payment.
Cons of personal loans
- You’ll likely pay a higher APR with an unsecured loan
- A low credit score can make it more difficult to get the lowest available APR
- You may have to pay an origination fee to process the loan
“Even for those with good credit that can borrow at low rates, the cost of borrowing is still much higher than if they had an emergency savings reserve sufficient to draw on instead,” McBride says.
The biggest pitfall occurs when the consumer pays off the $12,000 credit card with a personal loan, but then begins to use the card again and ends up running the balance back up to $12,000, Triggs says.
“Now they have to pay that and the personal loan, which in this scenario will be a challenge,” he says.
Another disadvantage of personal loans is that there are few payment options if you lose your job or otherwise can’t afford to pay it. Most credit card companies will work with consumers who suffer real hardship, Triggs says.
How to apply for a personal loan
How to get a personal loan in 7 steps:
- Run the numbers
- Check your credit score
- Consider your options
- Shop around for the best rates
- Pick a lender and apply
- Provide necessary documentation
- Accept the loan and start making payments
Frequently asked questions about personal loans:
What is APR?
APR stands for Annual Percentage Rate. APR refers to the extra amount borrowers pay in interest and fees on an annual basis. Lenders calculate APR on a yearly basis, but borrowers are most often responsible for paying APR on a monthly basis.
For more detail on how APR can affect your monthly payments, check out our personal loan calculator.
What's the difference between a secured loan and an unsecured loan?
Secured loans are backed by a piece of the borrower’s property as collateral, typically a vehicle or house. Because the borrower stands to lose personal property if they default, secured loans tend to have lower interest rates.
Unsecured loans are not backed by collateral, but instead by the borrower’s creditworthiness. Because the lender takes on more of a risk with an unsecured loan, interest rates tend to be higher. Lenders also require that borrowers seeking an unsecured loan have a higher-than-average credit score.
What's a repayment term?
A repayment term refers to the length of time borrowers have to repay their loan. A personal loan's repayment term can vary between one and ten years, depending on the lender.
How does my credit score affect my offer?
Because personal loans are often unsecured, they may come with higher APRs. With unsecured loans, lenders tend to pay extra attention to a borrower's credit score.
The lower a borrower's credit score is, the more they'll have to pay in APR. Lower credit scores can lead to APRs in the double digits.
Loan rates differ by lender, but often opting for a secured loan can help lower APR, even for someone with bad credit. In some cases, secured loans can offer up to 8% less in APR than unsecured loans.
What’s the difference between fixed-rate and variable interest?
Depending on the loan and the lender, you may have a choice between fixed rate (which stays the same over the life of the loan) or variable (which can rise or fall depending on changes in the market).
The interest on a variable rate loan often starts low but may increase over time. The terms of the loan agreement will specify how often the lender is allowed to raise the interest rate, and some loans cap the maximum rate at a certain percentage. By contrast, the payments and interest charges on a fixed-rate loan will remain the same.
Base your decision on whether you prefer the stability of a fixed rate or the possibility of saving on interest with a variable rate.
The bottom line
The personal loan landscape has changed dramatically in ways that make it more efficient for both borrowers and lenders, McBride says.
“Credit availability is better, rates are more competitive and the quick turnaround is a sharp contrast from getting a home equity loan instead,” he says.
Personal loans that are used to pay off higher interest debt can be a great tool to save money on interest over time, Triggs adds.
“Avoiding the pitfalls of getting back into credit card debt, which is one of the biggest issues for consumers who struggle paying their personal loans, is critical to meeting your goal of paying off your debt in a shorter amount of time,” Triggs says. “Remember, you can never borrow your way out of debt. Moving debt from one place to another can save you money, but only your consistent payments and dedication towards your goal will get you out of debt.”