What is a personal loan?

Personal loans are a form of installment loan that lets you borrow a lump sum and repay it in fixed monthly payments. Personal loans come with interest, but the rate is usually much lower than what you'd pay on a credit card.

There are few restrictions on what a personal loan can be used for — you can take one out for home improvements, debt consolidation, or almost any unexpected expense.

Before applying for a personal loan, it's important to understand how they work, the requirements for approval and how to choose the right lender.

Personal loans provide a one-time cash payment that is repaid with interest over a predetermined term. Traditional banks, credit unions, and online lenders all offer personal loans, and while terms vary by lender, most have a fixed interest rate and predictable monthly payments.

You can typically get a personal loan for between $1,000 and $50,000, although some lenders offer up to $$250,000 for well-qualified borrowers.

Requirements

Each lender has their own qualifications for approval, but

• Credit score: You generally need a FICO Score of 580 or better to qualify for a personal loan. To secure favorable rates and terms, you typically need a score of 670 or better.
• Debt-to-income ratio: Ideally below 36%, although if you have a good credit score or significant savings, you may be approved with a DTI of up to 40% or 50%.
• Loan amount: Typically between $1,000 and $50,000
• Repayment terms: Most commonly two to five years
• Stable, verifiable income
• Government-issued identification, proof of address and recent income documentation

Interest and fees

Lenders charge interest on personal loans, but you may face other charges, such as an origination or administrative fee for processing the loan and reviewing your creditworthiness. Origination fees range from 1% to 10% of the total borrowed amount, although the average is usually between 1% and 5%.

The fee is taken out of your loan total, so if you borrow $10,000 from a lender with a 5% origination fee, you'll only receive $9,500. If you want 100% of your loan funds, LightStream does not charge an origination or application fee. (It also doesn't charge a late fee or prepayment penalty).

Your APR incorporates any fees you have to pay, making it a better measure of the overall cost of borrowing.

Terms

Lenders typically approve personal loans for terms of two to five years (24 to 60 months), though many lenders offer repayment periods as short as one year (12 months) or as long as seven years (84 months).

Some lenders, like LightStream, offer terms of up to 10 to 20 years (120 to 240 months) for large-scale financing like home improvement projects.

Funding and repayments

The money is electronically deposited into your account once you're approved, although you may be able to request a paper check or cashier's check. It can take several days after approval for the funds to appear, but lenders like Citibank and SoFi offer same-day funding. ( If you're getting a loan to refinance existing debt, you may be able to request that your lender pay your bills directly.)

You'll typically need to make your first payment within 30 days of funding. Many lenders offer a 0.25% discount for setting up autopay.

There are a variety of different personal loan options.

1. Secured personal loan. A secured personal loan is backed by collateral, like a vehicle, house or savings account. A borrower with weak or no credit may be approved for a secured personal loan or receive a more favorable rate. But if they fail to keep up with payments, the lender can claim the asset.

Not all lenders offer secured personal loans. We like that OneMain Financial approves them for up to $30,000 and works with borrowers across the credit spectrum. Best Egg is a good option for homeowners who don't want to risk their house — it uses fixtures in your home (like your kitchen cabinets and bathroom vanity) as collateral.

Unsecured personal loans. Because unsecured personal loans don't require collateral, lenders look more closely at your credit history, income, debt-to-income ratio and other financial information to determine your eligibility and loan terms. Most personal loans are unsecured — the application is usually simpler and you don't risk losing any assets, although you may have a higher interest rate than with a secured loan.

Fixed-rate personal loans: Most personal loans have a fixed interest rate that stays constant throughout the repayment period, so your payment is predictable and easier to budget for.

PenFed offers fixed-rate financing in amounts as small as $600, while Discover can deposit your loan as quickly as the next business day.

Variable-rate personal loans: Variable-rate personal loans are rare, although SoFi allows borrowers to choose between fixed and variable APRs. Other institutions, like U.S. Bank, offer variable rates through personal lines of credit.

Debt consolidation loans: Personal loans used to tackle high-interest debts are often referred to as debt consolidation loans. You might use the loan to pay off several credit card balances and then make one monthly payment on the new personal loan with a lower, fixed APR. Some lenders will pay your creditors directly, and Achieve even offers a direct pay discount. (It also provides rate reductions if you have a co-borrower or proof of sufficient retirement funds.)

Upstart approves debt consolidation loans as small as $1,000 and as large as $75,000. It also considers factors beyond your credit history, including work experience and education.

Peer-to-peer (P2P) loans: P2P loans originate on online platforms that connect borrowers directly with individual or institutional investors, sidestepping the need for a bank. The platform typically evaluates your application and creditworthiness before determining whether you qualify and with what terms.

P2P rates, fees, loan amounts and eligibility requirements vary by platform. The P2P marketplace Prosper offers next-day funding and lets co-borrowers submit a joint personal loan application.

Payday loans: Payday loans are short-term, high-cost loans designed to be repaid when you receive your next paycheck. They provide quick access to cash, but often carry predatory fees and borrowing costs. Failing to pay off a payday loan can lead to a debt cycle that's increasingly hard to escape.

If you need a smaller amount of money quickly, cash advance apps may be an alternative worth exploring Chime MyPay offers up to $500 per pay period with no transaction fees or subscription charges. MoneyLion InstaCash approves advances of up to $500 or up to $1,000 with qualifying direct deposits to a MoneyLion RoarMoney account.

While APR (annual percentage rate) is an important factor in choosing a lender, there are many other criteria.

1. Decide how much you need

A low APR doesn't help if the bank's minimum is more than you need. A larger loan can mean substantially more interest, even if the monthly payment still looks manageable.

2. Compare APRs, not just interest rates

The APR incorporates upfront fees, making it a more accurate indicator of the cost of borrowing and a better way to compare offers. A lender advertising a 7% rate may cost you more than one charging 7.5% if there's a sizeable origination fee.

3. Look at the terms

A shorter term means paying less interest in the long run, but it won't help if the payments are so high they leave you strapped for cash. Choose the shortest term you can comfortably afford each month.

4. Compare fees

Look for:

• Origination fee
• Application fee
• Late fee
• Returned-payment fee
• Prepayment penalty

Not all lenders charge all (or any) of these fees, but each situation is different. You may still get a better deal with an origination fee than from a lender that doesn't charge one.

5. Review multiple offers

Many lenders will let you prequalify with a soft credit inquiry, so you can compare potential rates without hurting your credit score. Compare offers from at least three to five lenders, including banks, credit unions, and online lenders.

6. Consider your personal needs

No two borrowers have the same financial needs. If you need money fast, check the lender's typical funding timeline. If you're paying down debts, you'll want to see if they'll pay your creditors directly. If you prefer discussing financing face-to-face, a lender with physical branches is a better option than an online bank.

Do some research before you apply for a personal loan. Familiarize yourself with CNBC Select's best personal loans and, when you're ready to apply, follow these steps.

1. Review your credit. Look at your credit score and reports from all three credit bureaus before applying, so there are no surprises. Make sure your score is high enough to get approved by lenders for a rate you are comfortable with. If you find an error on your credit report, dispute it before applying.

2. Shop for the best rate. Get prequalified so you can see what rate and term you're likely to be offered before submitting a formal application. You can submit your information to the lenders that interest you, or use a lender marketplace like LendingTree.

3. Gather your documents. Once you've chosen a lender and are ready to apply, you'll need several documents and pieces of personal information. These can include:

• Your Social Security number
• Address and telephone number
• Government-issued ID, like a passport or driver's license
• Proof of income and employment
• Bank account and routing numbers
• Information about current debt
• Tax returns (if you're self-employed).

4. Submit the application. The lender will perform a hard credit inquiry and may verify your income and other information. Approval can take anywhere from a few minutes to several business days, but online lenders tend to approve and fund loans faster.

Submitting applications to multiple lenders at once can damage your credit. Try to get prequalified and choose the one that best fits your needs. If you are turned down or receive unfavorable terms, you can consider applying with another lender.

5. Review and accept the loan agreement. If you are approved, look at the APR, fees, loan term and total repayment amount before accepting to make sure you're comfortable with them.

6. Get your funds. Once you accept the loan, the lender will deposit the money into your bank account (or send it to your creditors, in the case of a debt settlement loan). LightStream and Discover both offer same-day funding for eligible borrowers.

7. Set up repayment. Your lender will tell you when the first payment is due. Consider automatic payments—they'll keep you from missing a due date, and you may get a discount.

While a personal loan can provide quick cash, there are drawbacks to consider.

Pros

• Usually has a lower APR than a credit card.
• Funding can come the same day or the next business day.
• Fixed rates, payments and payoff date make it easier to budget.
• Can be used to consolidate debt.
• On-time payments can help your credit score.

Cons

• You'll need good credit to secure the best rate and terms
• Origination fees can reduce the amount you actually receive
• A long repayment term can make a loan much more expensive.
• Requires a hard credit inquiry, which will temporarily lower your credit score
• Secured loans can put your car, home or other assets at risk.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every loan article is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of financial products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

Catch up on CNBC Select's in-depth coverage of credit cards, banking and money, and follow us on TikTok, Facebook, Instagram and Twitter to stay up to date.