What Is a Personal Loan?

A personal loan is an amount of money you borrow to use for a variety of purposes. For instance, you may use a personal loan to consolidate debt, pay for home renovations, or plan a dream wedding. Banks, credit unions, and online lenders can offer personal loans. The money you borrow must be repaid over time, typically with interest. Some personal loan lenders may also charge fees for their loans.

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How a Personal Loan Works

A personal loan allows you to borrow a lump sum of money to pay for a variety of expenses and then repay those funds in regular payments, or installments, over time. For example, you might use a personal loan to cover:

 
  • Moving expenses
  • Debt consolidation
  • Medical bills
  • Wedding expenses
  • Home renovations or repairs
  • Funeral costs
  • Vacation costs
  • Unexpected expenses
 

Personal loans are different from other installment loans—such as student loans, car loans, and mortgage loans—that are used to fund specific expenses like education, vehicles, or homes.

A personal loan is also different from a personal line of credit. A line of credit is not a lump sum amount but instead works like a credit card. You have a set credit line that you can spend money against. As you spend, your available credit is reduced. You can then increase available credit by making a payment toward your credit line.

With a personal loan, there’s typically a fixed end date by which the loan will be paid off. A personal line of credit, on the other hand, may remain open and available to you indefinitely as long as your account remains in good standing with your lender.

 

The Internal Revenue Service (IRS) does not consider a personal loan as part of the borrower’s income. The money received on the loan is not taxed. However, if the lender forgives the loan, it is considered a canceled debt, and that amount can be taxed. 

Types of Personal Loans

Personal loans may be secured or unsecured. A secured personal loan requires some type of collateral as a condition of borrowing. Comparing the rates for secured loans from the best lenders is advisable. For instance, you may secure a personal loan with cash assets, such as a savings account or certificate of deposit (CD), or with a physical asset, such as your car or boat. If you default on the loan, the lender could keep your collateral to satisfy the debt.

 

An unsecured personal loan requires no collateral to borrow money. Banks, credit unions, and online lenders can offer both secured and unsecured personal loans to qualified borrowers. Banks generally consider the latter to be riskier than the former because there’s no collateral to collect. That can mean paying a higher interest rate for a personal loan.

How a Personal Loan Works

To get a personal loan, you need to apply to a lender. Again, this can be a bank, credit union, or online personal loan lender.

 

Generally, you would first complete an application. The lender reviews it and decides whether to approve or deny it. If approved, you’ll be given the loan terms, which you can accept or reject. If you agree to them, the next step is finalizing your loan paperwork.

 

When that’s done, the lender will fund the loan, which means paying you the proceeds. Depending on the lender, these may arrive through a direct deposit into your bank account or a check. After the loan is funded, you can use the money as you see fit. You then have to begin repaying the loan according to the terms established in your loan agreement.

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