Personal Loan: How It Works

(April 2024)

Personal Loan: How It Works

In This Article

Do you have an urgent financial obligation to meet and wondering how personal loans work? If yes, congratulations! Maybe it’s your lucky day. A personal loan comes handy when the need to consolidate debts, meet emergency needs or clear bills arises. This article teaches you everything you need to know about personal loans, how they work, and how to apply and get an approval.

  1. Personal Loan: Definition
  2. Personal Loan: How It Works
  3. Personal Loan: What to Know Before Applying
  4. Personal Loan: How to Qualify
  5. Personal Loan: Where to Apply
  6. Personal Loan: How to Apply
  7. Personal Loan: What to Do if You Get Denied

1. Personal Loan: Definition

To understand how a personal loan works, know what it is. A personal loan is a lump sum of money you borrow to meet your needs. It always comes with interest and a fixed monthly repayment amount. You use a personal loan for a variety of purposes, including debt consolidation, home improvements, new car payment or medical bills settlement, among other things. Different factors such as credit score, loan purpose and amount requested determine how much of a personal loan you can qualify for.

2. Personal Loan: How It Works

To get a personal loan, familiarize yourself with how it works. Personal loans come handy when you have urgent needs to meet. They can be secured or unsecured. When you request a secured loan, you present collateral to your lender. You forfeit your asset if you default. Auto loan and mortgages are examples of secured loans. Alternatively, you can apply for an unsecured personal loan—you require good or excellent credit, though.

Usually, before you receive a personal loan, you and the lender agree on the interest rate, repayment term, and monthly installment payment. The lender deposits a lump sum into your account, and you pay back according to the agreed-upon repayment method. Personal loans have fixed interest rates, except when you default on your payments. If that happens, the lender can increase your initial interest rate to account for the new increased credit risk you pose as a borrower.

3. Personal Loan: What to Know Before Applying

Before you apply for a personal loan, take note of the following:

  • Assess your need to know the exact amount you need and which you can repay with little to no friction. Avoid the temptation to borrow more than you need or more than you can repay even if you qualify for it.
  • Compare different offers before you choose the right one for you.
  • Be careful and don’t overlook any fee. This is very important! Ensure your lender clarifies all fees—and ask questions if you don’t understand what justifies a fee.

4. Personal Loan: How to Qualify

To get a personal loan, understand how to qualify for it. Lenders are out to make profits on the interest rates they charge—and because not all borrowers repay, lenders create requirements in order to approve the best candidates. To qualify for a personal loan, understand what the lender requires and check if you are the lender’s best match.

Want to know whether you have a chance of getting a personal loan approval? Compare the lender’s requirements versus your loan amount, credit score (ideal score is 640+ for an unsecured personal loan), past loans payment history, debt-to-income ratio (ideal percentage is anything less than 30%), and so on. If everything resonates well with what your lender demands, congratulate yourself in advance for a successful personal loan application.

But understand that the factors above are not exhaustive. The specific loan requirements vary from one lender to another. Make sure you’re comfortable with the lender’s interest rates, repayment terms and conditions before submitting your application.

5. Personal Loan: Where to Apply

To get a personal loan, know where to apply. You can get a personal loan from your bank or credit union, online lenders, family or friend member, and peer-to-peer lending site. If you have bad credit, you may zero in your applications on lenders who do not prioritize creditworthiness to approve your personal loan application.

Your credit score is bad if it falls below 580, and your chances of getting a personal loan decline—especially if you lack collateral as leverage.

6. Personal Loan: How to Apply

To obtain a personal loan, learn how to apply for it. First, you clarify why you need a personal loan, know the type of loan you need, and check the lender’s requirements. Next, submit your application. Below, check the t’s to cross and the i’s to dot before submitting your application: 

  • Review your credit score. Work to increase your credit score if the lender requires good or excellent credit and you have bad credit. 
  • Research different lenders’ offers. Compare different lenders and check their interest rates and repayment terms. Choose the one that works best for you. 
  • Present necessary documents. Ask your lender the documents to provide for application of a personal loan. Prepare documents like bank statements, proof of income, proof of debt, and any other files your lender requires.
  • Submit your application. Submit your application online or in-person depending on your lender.

7. Personal Loan: What to Do if You Get Denied

Wondering what next to do if your personal loan application gets denied? If yes, wonder no more by checking your disapproval notice (denial letter or decision letter) so you can understand what to improve on in your next application. If, for example, your lender declines your application due to bad credit, work towards boosting your credit score.

First thing first! Check your credit report to know what exactly is hurting your credit score and devise the next step of action. Getting a co-signer also adds credibility to your application and boosts your chances of getting an approval. One more thing to do is to apply for a smaller loan amount.

Recap

Getting a personal loan is easier if you can convince the lender you can repay. To get started, know what personal loans are and how they work. Know factors that boost your chances of getting an approval and check the lender’s eligibility requirements. Know where and how to apply. Know what to do next in case your lender declines your application.

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