Each year, millions of Americans use personal loans to consolidate debt, pay off unexpected expenses, and make home repairs. Personal loans help finance most major purchases, from small medical bills to home repairs, often at lower interest rates than paying with a credit card. Also, if you have a lot of high-interest credit card debt, you can take out a personal loan to consolidate your balances and lower your overall APR.

However, like any kind of financial product, personal loans come with trade-offs such as fees and interest rates. Consumers should think carefully before applying for credit as it can affect their credit score and overall financial health.

According to TransUnion, the number of people taking out personal loans has grown from 15 million to over 20 million in recent years.

What is a Personal Loan?

A personal loan is a type of installment loan. Unlike credit cards, personal loans provide the borrower with one-time cash payment. The borrower repays that amount plus interest in regular monthly installments called the term of the loan.

With the rise of peer-to-peer and online lenders, there are hundreds of quick and simple fast loans options, and in most cases, it takes less than 10 minutes to apply online. However, depending on how quickly the lender receives and processes the documents, the full approval process may take up to 1 business week. At the very least, personal loans pay interest. You may also incur other charges such as: Any processing or administration fees that will be deducted from the loan amount after approval or prepayment penalties if the loan is repaid before the term expires.

How Do Personal Loans Work?

When a personal loan is approved, the money is usually deposited directly into your checking account. If you take out a loan to refinance existing debt, you may be able to require your lender to pay your bills directly.

No matter how you receive the money, be prepared to start paying it back within 30 days. With a fixed rate loan, your monthly payment will remain the same until you pay off the loan. With a variable rate loan, the interest rate fluctuates and the amount you owe may change from month to month. Once the personal loan is paid off, the line of credit is closed.

Types of Personal Loans

There are two types of personal loans as follows:

Unsecured Personal Loans: An unsecured personal loan has no collateral. Lenders will determine if you are eligible based on your financial history. If you don’t qualify for an unsecured loan or would like a lower interest rate, some lenders also offer secured loans.

Secured Personal Loans: A secured personal loans is backed by collateral such as savings account or a property. If you are unable to make payments, the lender usually has the right to recover your property as loan payment.

How Do These Online Loans Impact Credit Score?

When you apply for a loan, the lender collects the credit as part of the application process. This is called a hard request and usually lowers your credit score by a few points. This hard query usually remains on your credit report for about two years.

If you’re looking for the best rates, some lenders with whom you already have an account will check your credit history. This is called a soft referral and does not affect your credit score. Consider checking interest rates with lenders that make soft pulls and don’t affect credit ratings.

Before you sign the loan agreement, you should add up all the costs associated with the loan, not just the interest rate, to determine the total amount you are responsible for paying back.