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How Do Personal Loans Work?

When you have big expenses, a personal loan can give you the funds you need.

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By Mary Beth Eastman

Written by

Mary Beth Eastman

Freelance writer

Mary Beth Eastman has covered personal finance for more than seven years and is an expert on mortgages, student loans, and insurance. Her work has been featured by U.S. News & World Report, Newsweek, and Money Under 30.

Edited by Jared Hughes

Written by

Jared Hughes

Writer, editor

Jared Hughes has over eight years of experience in personal finance. He has provided insight to New York Post and and NewsBreak.

Reviewed by Meredith Mangan

Written by

Meredith Mangan

Senior editor

Meredith Mangan is a senior editor at Credible. She has more than 18 years of experience in finance and is an expert on personal loans.

Updated January 31, 2025

Editorial disclosure: Please note that this article contains affiliate links. If you click through and purchase a product from one of our advertising or lending partners, we may earn a commission. The amount of commissions do not affect our editors' opinions or recommendations. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.” Please read our affiliate disclosure for more information.

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A personal loan provides you with a lump sum of money upfront that you pay back over time. Personal loans can help you cover large purchases or unexpected financial issues, such as a car repair, home renovation project, or medical expenses.

You could also qualify for a lower interest rate on a personal loan compared to a credit card. The average interest rate for a two-year personal loan was 12.32% in 2024, according to the Federal Reserve, while a credit card's average rate was 21.47%. But keep in mind that the rate you get depends on your credit profile. 

What is a personal loan?

A personal loan lets you borrow money when you need funds to cover a big purchase or expense. The cost to borrow money with a personal loan is expressed as the loan's annual percentage rate (APR), which is the interest rate plus any upfront fees.

And payments are generally made in fixed monthly payments — meaning the monthly payment won't change over the life of the loan. You can get a personal loan from a bank, credit union, or online lender, and funds may be available as soon as the same day you apply or the next business day, in some cases.

Personal loans can be used for a variety of purposes, including:

You may also be able to use a personal loan to fund a special trip, a new car, truck, or boat. Most lenders ask what you intend to use the loan for, as some loan purposes are generally restricted — like paying for college tuition or a down payment on a home.

How does a personal loan work?

When you take out a personal loan, you receive a lump sum that you pay back over time with interest. Personal loans may have lower interest rates than credit cards, which can make it more affordable to borrow for big-ticket items or expenses.

Terms are usually between 1 and 7 years, with some lenders offering longer terms in some cases. Longer terms can shrink your monthly payments, but they'll cost you more in interest, while shorter-term loans may have a higher monthly payment for the same amount borrowed, but less overall interest.

Interest and fees

In addition to interest, some personal loans charge an upfront fee, often called an origination fee or sometimes an administrative fee. This fee can range from 0% to 12% of the loan amount, depending on the lender and your credit profile. There are a few things to know about origination fees:

  1. They're often deducted upfront from the loan amount.
  2. The origination fee is accounted for in the loan's APR, which is why it's best to compare APRs over interest rates.
  3. The better your credit score, the easier it is to avoid origination fees.

If you make late payments or have insufficient funds in an account from which a payment is made, you may also be charged late fees and/or NSF fees. However, some lenders, like LightStream, charge neither late fees nor origination fees.

Check Out: Best Personal Loans With No Origination Fee

Qualifying for a personal loan

To qualify for a personal loan, lenders usually consider your credit history, income, debt-to-income ratio (DTI) — your existing monthly debts (credit card balances, auto loans, mortgages, and so on) compared to your gross monthly income — as well as your employment status.

But before you apply, prequalify. Prequalification is a way to get a sense of the loan types and rates you might qualify for without submitting a full, formal application. It won't hurt your credit, and can show you rates and terms that specific lenders think you'll qualify for.

You'll generally need to provide at least your name and contact information, as well as the loan purpose, loan amount, and sometimes your Social Security number (or the last four digits).

Note that once you go through the full application process (prequalification only takes a few minutes and doesn't require documentation), the lender will conduct a hard pull on your credit, which could ding your score by a few points, usually for no longer than one year.

What is the personal loan borrowing process?

Borrowing a personal tends to follow the same steps no matter which lender you use:

Prequalify

Prequalification is like a mini-application the lender uses to estimate loan terms (APR, loan amount, repayment period) before you apply. A prequalification is an important tool because it allows you to compare preliminary quotes from several different lenders.

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Good to know

In general, prequalifications don’t hurt your credit score because it involves a “soft” pull as opposed to a “hard” pull, which usually takes place when you apply.

Compare lenders

Once you've prequalified, compare quotes based on APRs, repayment terms, monthly payments, loan amounts, and whether any upfront fees are charged. Once you've found the lender with the best terms, research reviews on sites like the BBB and Trustpilot. If all looks well, prepare to apply.

Apply

Submit a formal application to get an official loan offer from the lender of your choice. Lenders use your personal and employment information, income, and credit and debt profile to determine if they will lend to you and, if so, what the terms of your loan will be. At this stage, most lenders conduct a hard credit inquiry which could ding your score for up to one year.

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Important

Approval may be nearly instantaneous or occur within hours. In some cases, it could take days to approve your loan, especially if you’re self-employed

Receive funds

In general, a lender will send the money to a bank account you choose or to your creditors if you're consolidating debt. Some lenders offer same-day funding, such as Sofi and LightStream, if you are approved before the lender's same-day funding cutoff time. Most send funds the next business day or within a few business days.

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Tip

If you’re approved and accept the loan terms, it typically takes anywhere from less than a day to multiple days for your lender to fund the loan.

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