personal loan

How Does a Personal Loan Work? Common Myths About Taking Out a Personal Loan


“How do loans work” is a common question asked on internet search engines. But, it’s important to understand the difference between the various types of loans available. And it’s all dependent on a lot of different factors about your financial situation. That’s why it’s important to do your research before applying for any random loan. And that research starts right here. If you’ve been asking yourself, how does a personal loan work, or you’re wondering how to take out a personal loan, then you’re in the right place. We’re breaking down everything you need to know including some common myths about personal loans. Keep reading to learn more.

What is a Personal Loan?

A personal loan is very different from a secured loan, also called a collateral loan. In this circumstance, there is no collateral required in order to secure funds. Similarly, however, you will have a term for repayment with interest charges.

You must apply for a personal loan through an approved financial institution such as your bank or credit union. There are several companies that service loans online, as well.

How Does a Personal Loan Work?

A personal loan works similarly to any other type of borrowing. Once you are approved, the loan funds will be disbursed to you. You will have a monthly payment until the loan has been paid in full as stated in the terms and conditions of the loan.

Your loan processor will obtain a copy of your credit report in order to determine the interest rate on your loan. You will need to provide proof of identity and income in order to qualify and obtain your funds.

Smart Ways to Use a Personal Loan

Used responsibly, a personal loan can enhance your finances. Let’s take a look at some ways a personal loan can benefit you.

Build Credit

Having a diverse range of debt and making your payments on time builds your credit score over time. Even if you have a good credit score, a personal loan adds that diversity to push it into the excellent range which will help you obtain lower interest rate loans later for things like cars or a new home.

There are also personal loans that don’t require a credit check. You can read more about these loans at this preceding link.

Save Money

If you have a credit card balance with a high-interest rate, obtaining a personal loan may be a way to save money. Often times personal loans offer lower interest rates than credit cards. You can use the loan to pay off the balance on the credit card.

A tip: don’t use your credit card while you’re paying the loan down in order to avoid getting into a revolving debt cycle.

Get Out of Debt

Taking out a personal loan to pay off multiple credit cards is another way to save money and get out of debt faster. It’s also easier to make one monthly payment with a set date for a payoff.

What NOT to Use a Personal Loan For?

While the funds of a personal loan are for you to use at your own discretion, there are a few things you should avoid using one for.


Running short on cash but need a vacation? It may be enticing to think about securing a personal loan if you want to get away but it can extremely costly. It’s better to save up and pay cash for your travels so you can enjoy the time away without worrying how you’re going to pay it back.


A wedding is a big expense that can be difficult to save up for, whether you’re the parents of the couple or the couple. You may be better off securing a home equity line of credit or saving for a few more years to pay cash instead.

Car Repairs

Using a personal loan to pay for auto repairs doesn’t really make sense. If you want a loan payment for your car, you may be better off financing a new one. The interest rate will likely be lower and you may even be able to pay it off sooner.

Common Myths About Personal Loans

Another popular search on the internet regarding personal finances is “are personal loans bad?” That’s because of a few common myths that can actually be true about some loans and loan companies. It’s important to be cautious when shopping for a personal loan to be sure you’re getting the best rate and terms.


Insurance is not required for personal loans.

Many loan providers will offer and even prompt you to purchase additional products like life insurance and unemployment insurance for additional fees on your loan. Most of these policies are poor in value compared to those products in other sectors of the finance world, make sure to read the fine print and ask a lot of questions if you think one of these policies is necessary on your loan.

Interest Rates

Some people think that interest rates on personal loans are higher than credit cards. That may be because of low credit ratings. It’s important to weigh the difference in your costs according to your credit score when taking out a personal loan or applying for credit cards.

Prepayment Penalties

Paying off a personal loan early may incur additional charges with some finance companies. It’s best to stay away from these types of loans because there is no way out of the additional interest and penalties.

Final Thoughts

Now that you have the answer to that burning question ‘how does a personal loan work’, you can feel confident in the rest of your research. Keep these tips in mind if you do decide to take out a personal loan so you don’t find yourself in any sort of financial trouble.

Don’t go just yet. Here’s a helpful post about different ways to pay for home repairs. It may help you avoid taking out a personal loan!


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