What Is a Personal Loan? How Do They Work?

If you’re shopping for a personal loan, the interest rate is likely your top priority. Your rate determines the true cost of borrowing, and knowing what to expect can help you find the best deal.

Personal loan rates currently range from 6% to 36% APR, depending primarily on your credit score. The average rate for a 24-month personal loan is 11.65%.

In general, borrowers with excellent credit typically qualify for lower rates, while those with fair or poor credit often see rates toward the top end of the range.

Personal loan rates by credit score

Your FICO® credit score can affect your personal loan rates. In general, you’ll get a better rate with a credit score that falls in the “good” range or higher. If you have an “exceptional” credit score, you’ll likely qualify for the best rates from your chosen lender.

Here’s how FICO breaks down your credit score into different tiers:

The actual rate you’re offered by a lender will depend on factors beyond your credit score, including income and loan term. You might find that you’re offered different rates with different lenders, which is why it’s smart to shop around before deciding on a loan.

What’s considered a good personal loan rate?

A “good” rate is relative to your credit tier and the current market. Any rate below the national average 24-month finance rate of 11.65% is considered competitive. The key is to compare multiple offers from different lenders to ensure you’re getting the best rate for your situation.

Lenders consider several factors when determining your personal loan interest rate. Understanding these can help you see where you stand and what you might improve.

Your credit score and history

Your credit score is the most significant factor lenders consider when setting your rate. A higher score demonstrates responsible credit management, which typically results in lower rates.

Loan amount and term length

The amount you borrow and your repayment term also affect your rate. Larger loans and longer terms typically carry higher interest rates because they pose greater risk to lenders.

Income and debt-to-income ratio

Lenders evaluate whether you can afford the monthly payments by reviewing your income and your debt-to-income ratio (DTI).

If you want to secure the best possible rate, there are a few steps you can take before you apply.

Improve your credit before applying

Even a small boost in your credit score can help you qualify for a better rate. Here’s how to improve your credit:

• Check your credit report: Request free copies from the three major bureaus and dispute any errors.
• Pay down balances: Lowering your credit utilization can quickly boost your score.
• Make on-time payments: Payment history is the biggest factor in determining your credit score.

Compare multiple lenders

Compare rates from multiple lenders, including banks, credit unions, and online lenders. Many let you check your rate before applying with a soft credit pull, which won’t affect your credit score.

Consider a shorter loan term

If your budget allows for higher monthly payments, choosing a shorter loan term can often get you a lower interest rate. You’ll pay off the loan faster and spend less on total interest.

A personal loan is an installment loan that provides you with a lump sum of cash. The loan agreement, which you receive during the application process, outlines the loan amount, interest rate, and repayment term.

Once you’ve received the funds in your checking account, you’ll pay it back with interest in monthly installments. Personal loans often have relatively low fixed interest rates, making them ideal for covering major expenses.

Common features of personal loans

Personal loans typically share these common features:

• Loan amounts: Range from $100 to $100,000
• Repayment terms: Usually 12 to 84 months, with shorter terms offering lower rates but higher monthly payments
• Average rate: 11.65% for a 24-month personal loan
• Unsecured nature: Most personal loans don’t require collateral, which is why rates are higher than secured loans like mortgages

Each payment you make consists of the principal, which is the amount you borrowed, and interest, which is the cost of borrowing. The interest rate depends on your credit score, financial history, and current market rates.

Your interest rate plays a huge role in determining your monthly payment. Even a small difference in rate can change how much you pay each month and over the life of the loan.

Monthly payment examples by loan amount

Here’s how different loan amounts and rates affect your monthly payment on a 36-month term loan:

• $10,000 at 8%: $313 per month, with $1,281 in total interest
• $10,000 at 15%: $347 per month, with $2,480 in total interest
• $20,000 at 10%: $645 per month, with $3,232 in total interest
• $30,000 at 12%: $996 per month, with $5,871 in total interest

This is why securing a lower rate is so valuable – it can save you hundreds or thousands of dollars in interest charges over the life of your loan. Try a loan payoff calculator to see how different rates affect your total cost.

When you’re shopping around for a personal loan, pay attention to a few key factors to choose the best one for you:

• Interest rate. This figure significantly affects the loan’s overall cost. Look for a competitive rate, as a lower one can save you money over the life of the loan.
• Repayment term. Choose a term that offers monthly payments that fit your budget while keeping total interest costs reasonable.
• Fees. Review the loan’s fee structure, which may include origination costs, prepayment penalties, and late-payment charges. Origination fees, for example, typically range from 1% to 10% of the loan amount. Always look for loans with minimal extra charges.
• Funding time. Time is crucial, especially if you need funds for an emergency. Look for lenders with a reputation for quick approval and disbursement of loan funds.
• Repayment flexibility. Check if the lender provides flexible repayment options. Flexible repayment options can help you keep your budget on track.

When you’re ready to apply for a personal loan, follow these steps:

• Check your credit. Lenders will use your credit score to assess the likelihood that you will repay the loan on time. Review your credit report to see where you stand, and take steps to improve or build your credit score before applying if needed.
• Shop around. Compare interest rates, fees, and customer reviews for different lenders to find the one that best suits your needs.
• Complete an application. Once you’ve chosen a lender, apply and submit the personal loan requirements, such as identification and proof of income (pay stubs, tax returns, etc.).
• Receive the funds. If the lender approves your application, you can accept and receive your funds, which may take a few business days.
• Arrange repayments. Once you receive the funds, you can start making monthly payments. Set up automatic transfers to ensure you never miss a due date.

Personal loans can be used for a wide range of purposes. Here’s an overview of some common ways you can use personal loans.

Debt consolidation

A personal loan can help you consolidate high-interest debts like credit card balances or medical bills into a single monthly payment. This simplifies repayment and can save you money on interest. Plus, paying down high-interest debt can boost your credit score by lowering your credit utilization ratio.

Emergencies

A personal loan can provide quick access to funds if you’re faced with an unexpected financial event, like an urgent home or car repair. While an emergency fund is ideal, a personal loan can bridge the gap when you need more than your savings can provide.

Medical expenses

You can’t always plan for unforeseen medical bills, whether from an emergency or elective procedure. A personal loan can help you manage these expenses without facing late fees or collections.

Home improvements

Homeownership can be expensive, especially when you’re faced with renovation or repair projects. A personal loan can help you upgrade your kitchen, fix your roof, or replace your furnace without relying on credit cards or dipping into your retirement savings.

Even the easiest personal loans to get might not suit your needs. Luckily, there’s more than one option when you need cash fast. Consider these alternatives before deciding on the best route.

Paycheck advance

Consider a paycheck advance loan if you need a small amount of cash. This type of loan lets you borrow against your paycheck and often doesn’t charge fees or require a credit check.

Credit cards

A credit card is another practical option for smaller expenses. Many offer 0% introductory APRs, but you’ll need to pay off the balance before the promotional period ends to avoid high-interest charges.

Buy now, pay later loans

A Buy Now, Pay Later (BNPL) loan breaks purchases into smaller, often interest-free installments over weeks or months. However, BNPL only works for certain purchases, so it may not help with bills or other expenses.

Home equity loan

If you own your home, a home equity loan lets you borrow against your equity using your home’s equity as collateral. These home equity loan rates are usually lower than new consumer loan rates, but they also tie your home to the loan. If you don’t repay the loan as promised, the lender could foreclose on your home to recoup their money.

Home equity line of credit (HELOC)

A HELOC is similar to a home equity loan, allowing you to borrow against the equity in your home. A HELOC is an open line of credit that lets you borrow money as needed during a draw period. Like with a home equity loan, the biggest risk is losing your home if you default.

Understanding personal loans helps you make informed borrowing decisions. Whether you need funds for debt consolidation, emergency expenses, or home improvements, comparing rates from multiple lenders ensures you get the best deal for your financial situation. Remember, even a small difference in your rate can save you hundreds or thousands of dollars over the life of your loan.

To maximize your chances of securing the funding you need, check out our guide on how to get approved for a personal loan.