How to Choose the Best Personal Loan (2023)

Choosing the best personal loans for your specific financial situation can be difficult, but there are plenty of methods you can implement to help narrow down your search. Here’s what you need to know about choosing a personal loan that meets your needs.

Table of Contents

  • What is a Personal Loan?
  • How Personal Loans Work
  • How to Compare Personal Loan Lenders
  • Tips on How to Get a Personal Loan
  • Reasons to Get a Personal Loan
  • Personal Loan Pros and Cons
  • Secured and Unsecured: Types of Personal Loans
  • Frequently Asked Questions

What is a Personal Loan?

A personal loan is a form of credit in which you receive a lump sum of money, repaying it over a fixed period of time.

Personal loans are typically unsecured, so you won’t have to provide collateral to a lender. However, this means that personal loan lenders look closely at your credit score to evaluate whether you’re a good candidate for a personal loan. Lenders may also consider your income and credit history to determine whether to offer you funds.

Personal loans can be used for a wide variety of purposes, including refinancing old debt, home improvement projects and wedding costs.

You can find personal loans at banks, credit unions and online lenders.

How Personal Loans Work

Personal loans come with fixed rates — meaning your interest rate will remain the same over the life of the loan — and repayment terms, which define the amount of time you have to repay the loan.

Like most types of credit, personal loans come with interest rates and fees. Here are a few fees you may come across when taking out a personal loan:

  • Origination fees are a common fee that lenders charge to cover the administrative costs associated with offering you a loan. These fees typically come out of the overall balance of your loan, so you’ll want to budget for that extra cost if you select a lender that charges an origination fee.
  • Late fees are often charged if you don’t pay your minimum monthly payment on time. Lenders may also charge a returned payment fee if your account has insufficient funds to cover your payment.
  • Prepayment penalties typically aren’t charged with personal loans, but it never hurts to check with a potential lender to be sure. Prepayment penalties are a type of fee some lenders charge (mostly mortgage and auto loan lenders) if you pay your loan off early.

How to Compare Personal Loan Lenders

When shopping around for the best personal loans, here are a few tips to keep in mind to evaluate which lender may be the right fit for your financial needs.

  • Prequalify for a personal loan: Many lenders allow you to prequalify — also known as a soft-credit inquiry — which allows you to see your potential rates and terms without impacting your credit score. Prequalifying allows you to compare potential offers without causing your score to go down.
  • Evaluate fees: While many lenders charge a variety of fees for personal loans, some lenders don’t charge any. For instance, lenders such as SoFi and Lightstream skip fees altogether.
  • Compare annual percentage rates and terms: These details can determine the total cost you’ll pay to borrow money. The lower your rate, the less you’ll have to pay overall. When it comes to repayment terms, the longer your agreement is, the lower your monthly payments may be, but the more you’ll pay in total interest.
  • Look for unique perks: If you have a good credit score, you may qualify with lenders that offer perks to customers. For example, Marcus by Goldman Sachs allows borrowers to skip a payment after they’ve made 12 consecutive on-time payments.

Tips on How to Get a Personal Loan

Before applying for a personal loan, there are ways you can prepare ahead of time to streamline the process. Here are a few tips:

  • Improve your credit score. Qualifying for a personal loan depends heavily on your credit score and history. If your credit is less than perfect, consider working on improving your credit score so you can qualify with more lenders and better rates.
  • Check your credit report for errors. Mistakes on your credit report could be dragging your credit score down. Unfortunately, it’s not uncommon to discover errors on your credit report. If you find something incorrect on your credit report, be sure to dispute it with the reporting credit bureau(s) as well as the company making the erroneous claim.
  • Prepare documents ahead of time. During the application process, lenders will require that you verify the information you provide, including your identity, residency and income. You may have to provide documentation such as pay stubs, W-2s and a government-issued identification.

Reasons to Get a Personal Loan

Most lenders require that borrowers disclose how they plan to use their personal loan funds.

While many lenders are flexible regarding how you use the money, some have a prohibited list of uses. Typically, lenders bar you from using a personal loan for secondary education expenses, business costs or investing.

Here are some of the most common reasons borrowers take out personal loans:

  • Debt consolidation
  • Credit card refinancing
  • Home improvement projects
  • Medical bills
  • Travel costs
  • Wedding/honeymoon expenses

Personal Loan Pros and Cons

While personal loans offer many financial benefits, there are still some downsides. Here’s what to keep in mind when considering a personal loan:

Pros

  • Fixed interest rates protect loans from market fluctuations
  • Clear-cut payment schedules give borrowers insight into how long they’ll be repaying the loan
  • May find cheaper interest rates than on credit cards
  • Many lenders offer flexibility in how you can use your personal loan
  • No-fee lenders are available
  • Personal loans may be discharged in the event of bankruptcy

Cons

  • Lump sum may not be enough to cover expenses
  • Qualifying for an unsecured personal loan often requires a robust credit profile and high score
  • Sometimes come with origination fees
  • Lenders may have restrictions on how you can use your personal loan funds
  • Available loan amounts may depend on your level of income
  • If you are unable to repay a secured loan, you may lose your collateral

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Secured and Unsecured: Types of Personal Loans

Personal loans come in two different forms: secured and unsecured. While unsecured loans are the most common type of personal loans, some lenders offer both options. Here’s what you need to know:

  • Secured loans require the borrower to provide collateral to their lender, such as a vehicle or a savings account. If you obtain a secured personal loan and are unable to repay it, your lender may legally seize your collateral to recoup its losses. This type of loan may be best for those with low credit scores.
  • Unsecured loans do not require collateral. Instead, lenders rely on your credit score and history to decide whether or not to approve your loan request. It’s wise to make sure your credit is in good shape before applying. If you want to get an unsecured loan but have a low credit score, consider getting a personal loan with a co-signer.

Frequently Asked Questions

Even if you have a low credit score, you may still be eligible for a personal loan. Some bad-credit lenders that are willing to work with consumers who have low credit scores, but beware of predatory lenders that charge extremely high interest rates and fees. If you have poor credit, consider using a co-applicant or pursuing a secured personal loan to increase your chances of approval.

Term length always matters when selecting a loan, as a longer-term loan can carry a higher interest rate and origination fee for the same loan amount. It's always best to pay off your loan in the shortest amount of time, as you’ll accrue less interest.

However, if you aren't sure you can afford the payments on a short-term loan, you can opt for a longer term. This way, your monthly payments will be lower and you are less likely to default on the loan.

Yes — if your credit score has improved and you want to secure a lower interest rate, you can refinance your personal loan. Reducing your interest rate or shortening your loan term can save you quite a bit of money in interest over the life of the loan.

Annual percentage rates (APRs) are the overall yearly costs of taking out a loan. APRs are determined by your creditworthiness, the amount you borrow and your repayment terms. The APR you receive can also depend on the lender you use.

Depending on the lender, getting a personal loan can take anywhere from one to 10 days. First, you must go through an approval process, which can take several days. Once you’ve been officially approved, it can take several more days before you receive your loan funds.

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