Personal Loans: How They Work and What They Cost

A personal loan gives you a lump sum now and asks you to pay it back, with interest, in equal monthly payments over a set number of months. Most personal loans are unsecured, which means nothing you own is pledged as collateral. That is the main difference from a loan against your home. What a personal loan costs comes down to three things: the interest rate, any fees, and how long you take to repay.

The short version

• How you get the money: one lump sum, usually sent to your bank account.
• How you repay: the same payment each month for a fixed number of months.
• Interest rate: usually fixed, so the payment doesn’t change. Some lenders offer variable rates, so check which one you’re getting.
• Collateral: usually none. Your home isn’t on the line, but missed payments still hurt your credit and can lead to collections.
• What it costs: interest plus any fees. The APR is the best single number for comparing loans.

How the cost adds up

Numbers make this clearer. These use a made-up rate, not a current offer. Say you borrow $10,000 at an example rate of 12%.

The longer term lowers the monthly payment by about $110, but it costs about $1,390 more in interest. A lower payment isn’t a discount. You’re paying for the extra time.

Rate vs. APR vs. fees

The interest rate is the cost of borrowing the money. The APR, or annual percentage rate, folds in certain fees, so it shows the fuller cost. In the U.S., lenders must disclose the APR before you sign.

The fee to watch for is the origination fee, a charge for processing the loan. It’s usually taken out of the money you receive instead of being billed separately. Here is the effect, again with example numbers:

• A 5% origination fee on a $10,000 loan is $500.
• You receive $9,500, but you still repay the full $10,000.
• On the 36-month example above, the payment stays at about $332, but the cost of borrowing the $9,500 you actually receive works out to an APR of about 15.6%, not 12%.

Other charges to ask about include late fees, a fee for a returned payment, and any penalty for paying the loan off early. Many loans have no prepayment penalty, but some do.

What lenders look at

Each lender sets its own rules and weighs things differently. Common factors are your credit history, your income and job stability, how much you already owe compared with your income, and the amount and term you ask for. Some lenders look at other information too. Ask a lender what it considers instead of assuming. Approval, the amount and the rate are never guaranteed.

Who a personal loan tends to suit

• You know the amount you need and want a payment that never changes.
• You want to borrow without using your home as collateral.
• You’re paying off higher-interest debt and can get a lower APR, fees included. See debt consolidation loans.
• You rent, or you don’t have much home equity.

The risks

• Credit damage if you fall behind. Late payments can lower your score and stay on your credit report for years, and a lender can send a missed loan to collections or take you to court.
• It’s a fixed obligation. The payment is due whether or not your income dips. Make sure it fits your budget with room to spare.
• Fees shrink the money you receive. If you need an exact amount, ask for the amount you’ll receive after fees.
• Borrowing more than you need. A bigger loan costs more in interest, even if a lender approves it.
• Upfront-fee scams. A real lender takes any origination fee out of the loan itself. Be wary of anyone who asks you to send money first to release a loan.

Before you apply

1. Decide the amount you need and the monthly payment you can comfortably afford.
2. Check your credit reports for errors.
3. Compare more than one offer by APR, fees, term and total cost. Our guide on how to compare offers shows how.
4. Ask whether each step uses a soft or a hard credit check.

If a loan against your home is also on the table, see personal loan vs. home equity loan.

This article is for general information and isn’t financial, tax or legal advice. Example rates, fees and payments are illustrations, not offers.