Personal Loan

What is a Personal Loan? Personal Loan meaning and definition


A personal loan refers to a lumpsum amount of money you can borrow for any purpose. Most banks, credit unions, and online lenders offer personal loans.

Personal loans are available with minimal documentation, with or without any collateral or security. However, you will have to repay it over a particular period and interest specified by the lender. The repayment is usually made in the form of Equated Monthly Instalments (EMIs).

The amount you have to pay as EMI depends on your loan amount, the rate of interest approved, and the tenure of the loan. In addition, you may even have to pay some fees towards the processing of your loan.

Purpose Behind Personal Loan

Some loans like home loans, car loans, or student loans are available only to fund specific expenses. However, you can use personal loans for any purpose. Some of these include:

  • Moving expenses
  • Consolidation of debts
  • Medical Treatment
  • Wedding expenses
  • Vacation Costs
  • Home Renovations
  • Funeral Costs
  • Any other unexpected expenses

Nevertheless, a few lenders may restrict the usage of such personal loans by not letting you pay for education or any other specific purpose.

Personal Loan vs Personal Line of Credit

Unlike a personal loan, a personal line of credit does not offer you a lump sum amount. It is more like a credit card. There is a certain credit limit that will be approved for your loan. You can borrow whenever you require money but within this limit. However, as you borrow money, the available credit limit will keep reducing, unless you start making your payments.

Also, a personal line of credit does not come with a fixed end date like a personal loan. The line will be open and available till your account is intact with your lender.

Types of Personal Loans

Secured Personal Loans – You will have to offer collateral against the amount that you borrow for this type of personal loan. It could be a certificate of deposit (CD), a savings account, an FD or even a physical asset, like a car or house that the lender can use to satisfy your debt, in case you default.

Unsecured Personal Loans – These loans do not require any collateral or security. However, these are available only to qualified borrowers who do not pose a risk of defaulting on the lenders. These loans come with a higher interest rate when compared to secured personal loans.

How a Personal Loan Works

The first step in getting a personal loan is to apply with the lender. This lender could be a bank, a credit union, or even an online lending company. Find the loan application, fill it out, and submit it with the required documents.

The lender will consider your personal loan application and decide whether to approve or reject it. They will check your documents and eligibility for the loan. If your details like employment history, income, credit score, etc are up to their preference, your application will be approved.

Once the loan application is approved, the lender will share the loan terms with you. If you agree, the lender will finalize your loan paperwork. After that, the lender will transfer the specified loan amount into your account. In certain cases, you might receive a check. You can use this amount as per your requirements.

You have to repay the loan as per the terms mentioned in your loan agreement. If you default, you might end up damaging your credit score. In the case of a secured personal loan, you might lose your collateral. The lender can even sue you for debt collection.

Personal Loan Interest

Before applying for a personal loan, it is important to understand how much it will cost. A lot depends upon the agreed interest rate during the approval of your loan application.

Personal loan interest could be a flat interest rate or a decreasing interest rate according to your selection. With a flat interest rate, you will be paying the same EMI amount throughout your loan term. The interest here will be calculated on the total loan amount.

However, in case of a decreasing interest rate, the interest will be calculated only on the outstanding loan amount. So, once you make your monthly payment, that amount will be deducted from the outstanding loan amount. Then, the interest will be calculated on the remaining amount.

There are several factors a lender would consider before finalizing the interest rate. Some of these include:

  • Income – The higher your income, the lower the risk that you will pose to your lender. Hence the lender will offer you a lower interest rate. Applicants with lower annual incomes cannot expect to get loans at such low-interest rates.
  • Debt-To-Income Ratio – If you are repaying other debts, your lender will calculate how much of your income goes into paying these debts. They will finalize your interest rate depending on the calculation. The lower this percentage, the lower the interest rate you can expect on your personal loan.
  • Credit Score – A decent credit score is a must to qualify for a personal loan, especially if you have opted for an unsecured loan. To get a low-interest rate, you must have a credit score of at least 750.
  • Age – Age is another factor your lender may consider before deciding on your interest rate. If you are nearing retirement, you may not get a low interest rate.

The other factors include the nature of your employment, the organization you work for, and the kind of relationship you have with the lender.

The Bottom Line

Now that you have understood Personal Loan Meaning and how personal loan interest is calculated, it is time to search for personal loans. You can try the website of Piramal Finance to get a quick personal loan with minimal documentation. Make sure you understand all the repayment terms before signing the agreement.