Personal loan FAQs: Common questions answered

Key takeaways

• Personal loans provide a fixed amount of money to cover major expenses or consolidate debt, with repayments over time; they come as secured (with collateral) or unsecured (without collateral) options.
• Lenders evaluate your credit history, income, and debt levels to determine your eligibility and interest rate, which is generally lower if you have a strong credit score.
• Personal loans can be used for many legal purposes but not for illegal activities or gambling, and timely repayments can improve your credit score while missed payments may cause lasting damage.

Need extra cash but not sure where to turn? You might want to consider a personal loan. This financing option may be easier to qualify for than other types of loans if you’re eligible.

But it’s important to be aware of how personal loans work, how to qualify, the application process and documents involved, personal loan terms and conditions, income requirements, restrictions, how a personal loan can affect your credit score, when you’ll get your loan funds, and more.

Read on for helpful answers to every personal loan FAQ you may have.

Understanding personal loans

A personal loan is a form of financing that lets you borrow a set amount of money. Personal loan funds are typically used to cover significant expenses, pay off high-interest debt, or handle a range of other financial needs. These loans are repaid in fixed installments over a predetermined period.

You can choose among different types of personal loans based on your financial situation and borrowing goals. These loans typically fall into two categories: secured or unsecured. The former requires you to put up an asset for collateral, such as a savings account or a car. If you fail to repay the loan, the lender can claim your pledged asset to cover your debt. Secured personal loans typically charge lower interest rates because they’re backed by collateral. An unsecured personal loan, by contrast, doesn’t need collateral. You can qualify based on your income, credit history, and debt-to-income (DTI) ratio. But unsecured personal loans can charge higher interest rates and be more difficult to qualify for without pledged collateral.

What are the eligibility criteria for personal loans?

Your ability to qualify for a personal loan will depend on many different criteria, including whether you choose an unsecured or secured loan, your credit history and credit scores, and your earnings. Let’s take a closer look at some of these factors and requirements.

Credit history and its impact

One of the most important criteria your chosen lender will scrutinize is your credit history. After all, the lender wants to be sure you can and will pay back your debt. A higher credit score usually means you’ll be eligible for more attractive loan terms.

“For instance, an applicant with a great credit score, above 740, may qualify for a personal loan at a much lower interest rate compared to an applicant with a credit score below 600, who can end up with substantially higher interest rate offers or a loan denial,” says Dennis Shirshikov, a professor of economics and finance at City University of New York/Queens College.

Most lenders usually require a credit score between 610 and 640 to approve a personal loan, but this can vary. To qualify for better interest rates and loan terms, having a credit score of 650 or above is often necessary.

The lender will also review your borrowing history by performing a hard credit check. They’ll look for any missed payments, defaults, or other red flags. If your credit report shows past issues, it could lead to a higher interest rate or loan denial.

Income requirements

Your lender will also zoom in on your monthly and annual earnings.

“Lenders want to know that you can pay back your debt, so they will check how much money you make each month, typically by requesting copies of your paystubs, W-2s, 1099s, bank statements, and/or tax returns,” says Marigny deMauriac, a certified financial planner based out of New Orleans, Louisiana.

Every lender usually has its own minimum income level it sets to qualify for a personal loan.

DTI requirements

Your debt-to-income ratio (DTI) measures how much of your monthly gross income goes toward paying off debts. It’s one of the ways lenders assess whether you’re financially positioned to handle a new loan payment. Typically, lenders look for a DTI between 36% and 50% to approve personal loans.

“You don’t need to be rich, but you do need to show you can afford the monthly payments,” says Baruch Mann, CEO of The Smart Investor. “Lenders want to make sure your total monthly debt payments don’t eat up too much of your paycheck.”

What is the effect of getting prequalified?

Getting prequalified for a personal loan is a way to learn if you’re likely to get approved. Prequalification gives you an early estimate of the loan amount, interest rate, monthly payment, and terms you might qualify for before officially applying. During this process, the lender will perform a soft credit check to get a better idea of your debts, credit history, and overall financial status. Thankfully, this soft credit check doesn’t impact your credit score.

To get prequalified for a personal loan, you’ll need to provide a few key details, such as your name, address, income, date of birth, and Social Security number. This process gives you an early look at the potential loan amounts, rates, and terms you might be eligible for without a full application. Keep in mind, though, that not every lender offers a prequalification option.

“Also, remember that getting prequalified is not a promise that you’ll receive the loan,” says Shirshikov.

What is the application process for personal loans?

When you’re ready to apply for personal loan funding, it’s good to know what to expect. Here’s a breakdown.

Required documentation

You’ll begin the process by completing a form in person or online with your chosen lender. This form requests personal information like your name, address, Social Security number, employment status, income, and other financial data. You’ll be asked to submit requested documents to prove your identity and finances, such as a government-issued ID, proof of income in the form of pay stubs and W-2s, and sometimes tax returns and bank statements. If you’re self-employed, you may have to furnish extra documents like 1099 forms and profit-and-loss statements that help substantiate your monthly income.

“The lender might also ask how long you’ve been at your job and if your income is stable. Some lenders also want you to be a U.S. citizen or permanent resident and over 18 years old,” Mann says.

Missing any documents or paperwork can lead to delays in the entire process.

The steps of the application process

Applying for a personal involves several to-dos. Here’s what’s commonly involved, from start to finish:

1. Shop around among different lenders, both local and online lenders, and learn about personal loan products available.
2. To narrow down your options, determine how much you want to borrow and which loan features matter most to you.
3. Carefully compare interest rates and costs. Check the annual percentage rate (APR) for each lender and loan option; this gives you a more thorough idea of the total cost of the loan because it includes both the interest rate and any fees charged.
4. Review your credit by checking your three free credit reports. If you notice any errors or inaccuracies, get them resolved with the three credit bureaus (Equifax^®, TransUnion^®, and Experian™). Also, check your credit score, commonly available for free from your bank or credit card.
5. Gather important documents and details, including paperwork related to and validation of your earnings, job history, debt payments, savings, and overall finances.
6. Get prequalified for a personal loan.
7. Choose a preferred lender and formally apply. Complete the loan application form online, in person, or by phone and provide any documents or substantiation the lender requests.
8. If you get approved, carefully review the loan agreement and fine print, especially details related to your monthly payment, interest rate, fees, repayment schedule, and other conditions.
9. Agree to the terms, accept your loan, and receive your funds.
10. Repay your debt as agreed to. You’ll make regular monthly payments until the balance is paid off.

Differences between phone, online, and in-person applications

You may be able to apply for your loan online, by phone, or in person – depending on what the lender allows. Each option has its pros and cons.

“The information needed is roughly the same for all application types, but the convenience and speed of the process can vary,” says Shirshikov. “The fastest approvals tend to come with online applications, as they get processed more efficiently and enter the system more quickly. You may feel more secure with a phone application, which could involve a follow-up or require that you send in documentation. In-person applications could take longer, but you get a personal touch and potentially more direct contact with the lender.”

What are loan terms and conditions?

Every personal loan has its own details, rules, and agreements. These can include the amount borrowed, the agreed-upon interest rate, the length of the loan, and the total costs, which all should be specified in the loan’s fine print. Many personal loans have a term between 2 and 5 years, according to Mann.

“Typical terms and conditions stipulate that you agree to an interest rate the lender sets, borrow a certain amount of money, and pay it back in monthly installments,” deMauriac says. “You want to be sure to read the terms and conditions carefully before signing any documentation, and ask for clarification on anything confusing to you.”

Understanding interest rates

When it comes to interest rates, you can choose a fixed or variable rate. Fixed-rate personal loans have a set rate that doesn’t change over the life of your loan, which means you can count on consistent monthly payments. Variable-rate personal loans, on the other hand, adjust with market rate changes. Although you could begin with a lower initial rate, your monthly payments could go up if interest rates increase or go down if rates drop.

The interest rate on your personal loan is largely determined by your credit profile and credit score. Typically, the better your credit score, the lower the rate you’ll qualify for, which can save you money throughout the loan’s term.

“These days, interest rates for personal loans typically sit between 6% and up to 36%, and the best rates are given to borrowers with excellent credit,” says Shirshikov. “For example, a borrower with a strong credit profile may be offered a rate of around 8%, while a borrower with a lower score could pay a rate more in the vicinity of 25%.”

Common fees: origination and prepayment penalties

Be aware that your personal loan lender will probably charge an origination fee to cover the expense of processing your loan. This fee often equates to 1% – 10% of your loan amount. Case in point: on a $10,000 personal loan, a 5% origination fee could cost you $500.

Other charges can include late fees, insufficient funds fees in the event of a missed payment, and prepayment penalties. Prepayment penalties vary depending on the lender, with some charging a flat fee and others charging a percentage. For example, if you pay off a $2,000 loan early, some lenders may charge a fee equal to a percentage of the remaining balance, like 2% ($40), while others might charge a set number of months’ interest — such as 6 months at $20 per month, totaling $120.

What are the common uses and restrictions for personal loan funds?

The dollars from a personal loan can be used for nearly any legal purpose, including reducing credit card debt, paying for major events like a wedding, handling medical expenses or emergency expenses, and making a large purchase. These funds can also serve as a home improvement loan.

“One of its most popular uses is debt consolidation, in which you use the proceeds to pay off high-interest debt with a single lower-interest loan,” Shirshikov says.

It’s important to read your personal loan agreement thoroughly, as your lender may include particular restrictions. For example, personal loans cannot be used for gambling or illegal activities, which would violate your loan’s terms. Doing so could lead to costly penalties and even legal trouble.

“You also may not be able to use a personal loan for buying a house, which requires a mortgage loan, or investing in the stock market,” deMauriac says.

Additionally, the experts recommend not using personal loan funds toward college tuition since student loans usually offer better interest rates, longer repayment terms, and benefits like loan forgiveness and flexible payment options.

How does a personal loan impact my credit score?

A personal loan could hurt or help your credit score, based on how you manage it. Remember: When you apply, there’s a hard credit check that can cause a small temporary dip in your credit score. If you make your payments on time, your score can improve because this e you’ll be building a positive history and lowering your credit utilization ratio.

“But if you miss any payments or default on the loan, your credit score will take a hit that can last for years,” says Mann.

A personal loan won’t simply disappear from your credit history after you’ve paid it off. But it will be marked as closed or paid in full by the credit reporting agencies at the end of your loan term. A personal loan can remain in your credit reports for up to 10 years, depending on the reporting practices of the lender.

When will I receive my loan funds?

Typically, personal loan funds arrive in your designated financial account in just a few days – often 1 – 3 business days – after getting loan approval. This timing can vary depending on the lender’s practices and the disbursement option you select.

“In some cases, you can even get your money on the same day, especially if you choose direct deposit,” says Shirshikov.

Many personal loan lenders, including Rocket Loans^SM, offer same-day funding to those who qualify. Get started now with Rocket Loans and learn what rates and terms you may prequalify for.

The bottom line: Understand personal loan terms before applying

When you need money relatively fast, a personal loan can come in handy. Just be sure you understand what’s involved, including the interest rate, your chosen term, any fees charged, and whether you can afford the monthly payment. Shopping around among several different lenders and knowing how it can affect your credit score and credit history can help you make a more informed decision.

If a personal loan fits your needs, you can easily submit your application online today through Rocket Loans.