What you need to know before taking out a personal loan
What you need to know before taking out a personal loan

There is a lot to know when looking for a personal loan. For example, how is a personal loan different from more familiar types, such as car loans and mortgages? What can you use personal loans for? Are there alternatives to the personal loan?

To get the answers to these and other questions, Investopedia spoke with Linda M. Hooks, head of the economics department at Washington and Lee University in Lexington, Virginia. In addition to directing the largest department at Washington and Lee, Dr. Hooks has conducted and published research in various fields of economics. Our edited conversation follows.

How personal loans differ from other types of loans

Investopedia: To start, what is a personal loan and how does it differ from other types of loans?

Hooks: A personal loan is a fixed repayment loan intended for an individual consumer. An individual borrows money now and pays it back over a specific period of time by paying the same amount monthly. In this sense, it is similar to a car loan or a mortgage payment. It is different from these types of loans because it may not require collateral or valuables like a car or house that you agree to confiscate if you cannot repay.

Investopedia: What can personal loan funds be used for?

Hooks: Personal loans are versatile. They can be used for purchases too big to pay for in cash, such as a new appliance or an air conditioner. They can sometimes be used to consolidate other debts. They can be used for one-time expenses such as medical bills, school fees or maybe a special trip.

How to qualify for a personal loan

Investopedia: What are the qualifications required to apply for a personal loan?

Hooks: As with most loans, the main qualification is a good credit history. Sometimes it may be possible to use collateral for a personal loan, which may help you qualify for a personal loan or a better rate on the loan. Ask your bank what might be accepted as collateral, such as savings accounts or an insurance policy.

Investopedia: Where can people find out their credit score and does it cost money?

Hooks: Generally, you can only get a credit score by paying a fee. However, you can get a free credit report from the website AnnualCreditReport.com. You can find additional information about this service, including a phone number and mailing address if you prefer to order a report this way, on the Federal Trade Commission’s website titled Free credit reports. The information in your credit report forms the basis of the credit score. So you may not need to see the actual credit score, as long as your credit report appears accurate.

Factors that determine how much you can borrow

Investopedia: How do lenders determine how much people can borrow?

Hooks: To determine how much a person could borrow, lenders use credit score along with other factors such as possible collateral or an existing financial relationship with you.

Investopedia: What are some ways to improve your chances if you are not approved?

Hooks: If your application is denied, you have the right under federal law to know why it was denied. This can help you decide what to do next. Often the denial is due to a low credit score, and you can work to improve the score. Some steps to improving your credit score include paying bills on time and paying the required amount, which is at least the minimum payment required on a credit card. You should pay more than that, if possible. Do not charge the maximum allowed by your credit cards, i.e. keep the balance well below the maximum.

Prepayment, co-signers and other loan options

Investopedia: Can you repay a personal loan early or does it depend on the terms of the loan?

Hooks: Prepayment of the loan may be possible, but it depends on your specific loan. Ask before signing the loan documents if there would be a penalty associated with prepayment.

Investopedia: What is a co-signer and when might a borrower need one?

Hooks: A co-signer is an additional person who agrees to repay the loan if you cannot. Having a cosigner can help someone with a limited credit history get a loan. However, the co-signer should be aware that they are responsible for the loan in the same way as they would be if it were their own loan. It can also affect the co-signer’s credit history and score.

Investopedia: What are the alternatives to the personal loan?

Hooks: Alternatives to a personal loan may include a home equity loan or a credit card. Another alternative, if it is a planned expense, is to save for the purchase and only buy it after saving the funds for the item.

Protections available for borrowers

Investopedia: Where do you go to complain if you think your lender is doing something illegal or wrong?

Hooks: The Consumer Financial Protection Bureau (CFPB) was established under the Dodd-Frank Act of 2010 to provide consumers with resources and a means to file complaints about financial services.

Investopedia: What happens if you have financial problems and you cannot repay your loan?

Hooks: If you are having financial problems and think you will have trouble making a payment, contact your lender as soon as possible. There may be federal government programs that can help you as well, and you can find information about these on the CFPB website.

Final Thoughts

Investopedia: What final advice do you have for those considering a personal loan?

Hooks: Consider carefully the option of obtaining a personal loan. For example, in certain circumstances, it may make sense to forgo a personal loan so that you can instead qualify for a home loan.


Where do I go to get my credit score?

According to the Consumer Financial Protection Bureau (CFPB), there are four ways to get your credit score:

  • Check credit card or loan statements. Many major credit card companies provide your credit score on your monthly statement.
  • Talk to a nonprofit credit counselor. Non-profit, US Department of Housing and Urban Development (HUD)-approved counselors can provide credit scores and review them with you.
  • Use a credit score service. Some services offer a “free credit score” but require you to purchase a subscription. Others, funded by advertisers, charge no fees.
  • Buy your sheet music. Credit reporting companies will sell you your score. You can also buy your score on myFICO.com.

Is there a penalty for early repayment of my personal loan?

It depends on the terms of your loan. It’s always wise to find out about penalties, including prepayment penalties, before signing up for a loan.

Which is better: a private student loan or a personal loan?

A private student loan comes with lower interest rates, more repayment flexibility, and generally allows you to deduct interest payments on your taxes. If you need money to pay for college expenses, a private student loan is probably best. If you have other non-school related expenses, a personal loan may be preferable.


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