How do personal loans work?

What is a personal loan?

A personal loan is a lump-sum payment or line of credit, generally between $2,000 and $100,000, that you repay over a period of up to 7 years.

Personal loans are used for a variety of things, but generally, people tend to take them out for:

• Car purchases
• Paying for a wedding
• Doing renovations
• Paying emergency bills
• Consolidating debts
• Paying for a holiday

Since there are so many personal loan products and providers, it's important to shop around to find the best personal loan for you.

What can I use a personal loan for?

Personal loans can be used for a variety of reasons, here are some of the most common uses:

How do interest rates work with personal loans?

The interest rate is what you'll be charged by the lender for borrowing the money. And put very simply, the lower your interest rate, the lower your repayments will be.

When you make a repayment on your personal loan, part of that payment goes towards your loan and part of it goes towards the interest.

For example, a 10% interest rate on a $20,000 loan will cost you $2,000 a year in interest. However, since you are repaying the principal, by the time you have paid off $5,000 of the loan, your interest will be 10% of $15,000 - meaning your interest payable is now $1,500.

When it comes to personal loan interest rates, they're often personalised based on your financial circumstances. For example, the better credit score you have, the lower your interest rate will likely be. For this reason you'll usually see personal loan interest rates displaying with minimum to maximum rates (e.g. 6% - 19%).

How to compare interest rates

When it comes to interest rates, you need to keep a few things in mind:

• Fixed or variable rate: You may notice the terms 'fixed' or 'variable' interest. With fixed interest, your rate will stay the same for the duration of the loan, regardless of changes to the market interest rate. A variable rate of interest, in contrast, can mean an increase or decrease in your interest rate based on the market rate. This means that how much you pay in interest can change over the course of the loan term.
• Comparison rate: Most lenders provide a comparison rate, appearing next to the interest rate. The comparison rate is the 'true' interest rate once you take into account any fees. Watch out for low interest rates but much higher comparison rates, because it probably means you'll have high fees. The comparison rate is based on a specific loan amount and term though so you should always check if your own fees might differ.

What features come with personal loans?

Personal loans can differ in many ways other than the interest rate offered. While the interest rate is important, you may find that you save money with a higher interest rate loan that has certain features. We've outlined the most common features you'll find in the personal loan market:

Basic features

• Loan amount. This is how much you can borrow. Lenders set their limits based on whether the loan is secured or unsecured. How much of this you're eligible to borrow will depend on your personal circumstances and credit history.
• Loan term. This is how long you have to repay the loan. It can go up to 7 years, or in some instances, 10 years.
• Secured/unsecured. Some personal loans will require an asset as collateral for the loan. Others are unsecured, meaning you don't need to provide an asset to secure the loan.
• Loan use. Personal loans can generally be used for any worthwhile and legal purpose. Some personal loans may come with usage restrictions. For instance, green personal loans which can only be used for green home upgrades.

Extra features

• Extra repayments. You may be able to make extra repayments and reduce how much you owe. This in turn will reduce your interest payments. Some lenders offer free extra repayments, while others may charge, include limits or not allow extra repayments at all.
• Early exit. This is the ability to repay your loan in its entirety before the end of the loan term. Some lenders don't charge a penalty for exiting early, while others may charge a fee.
• Redraws. A redraw facility with your personal loan allows you to withdraw any extra repayments you've made. Some lenders offer free redraws, while others may charge or not offer it at all.
• Repayment flexibility. Some personal loans allow you to tailor your repayments according to your pay. This can be weekly, fortnightly or monthly repayments in line with your pay cheque.
• Mobile app. Some lenders have apps that can help you manage your personal loan from your mobile phone, making it more convenient and easy.
• Fast turnaround times. Some lenders offer quick funding, sometimes within a few hours or same business day. If you want the loan in a hurry, you should look into the lender's turnaround time.

How do I apply for a personal loan?

Once you've chosen your personal loan and checked the lender's requirements to make sure you're eligible, you can usually apply online. But whether you're applying online or in person, you'll need to complete the application form and provide all the supporting documentation.

You will usually need any of the following to prove your income:

• 3 payslips
• Bank statements
• 2 years of tax returns (if self-employed)

You'll also need to provide photo ID, such as your driver licence or passport, along with statements from other loan accounts or credit cards, if you have other debts.

Most applications are now online, which means that you'll have to attach your documentation to the online application. Some documentation, such as bank statements, can also be provided through read-only access to your account.

If you're applying with your existing bank, they'll have a lot of your information already and the process will be much faster.

If you're applying for a car loan, you'll need additional documents to have the car verified:

• VIN or chassis number, engine number and registration plate details
• The car dealer's contact information or the seller's contact details if a private sale
• Tax invoice and receipt for the car or purchase price if a private sale
• Your CTP insurance and comprehensive insurance details.

Expert insight: Improve your credit score

"Your credit score is a key factor lenders will look at when reviewing your application, so you can improve your approval chances by improving your credit profile. Paying down debts and building a track record of consistent on-time payments will help you increase your score over time.

If your loan application has been declined, you could ask the lender to share the reason for declining your application. It's also a good idea to check your credit file to see if there are any negative credit events (such as missed repayments) that could have contributed to the rejection and to spot any potential errors."

Jonathan Wu

Chief operating officer & chief product officer, MONEYME

How does the approval process work for personal loans?

With most personal loan applications available online, the approval process is much speedier than it used to be.

Some personal loan providers will promise near-instant approvals, but depending on your circumstances you may have to wait a few days.

Lenders will look at your personal circumstances and your credit history to decide if they're willing to lend you money. If you earn an income in a way other than a regular salary, or you have other debts, or you have a less than excellent credit score, the lender may need to take more time to look harder at whether you can repay the loan.

Generally, if you earn enough money, receive a reliable and regular income, and if your credit score is good, your chances of approval are higher. How much you want to borrow and whether you can afford the loan will also play a role. Lenders will also consider other eligibility criteria, like age (you have to be over 18) and residency (typically they will only accept your application if you're an Australian citizen or permanent resident, although there are some exceptions).

If you've been approved for the loan, you'll have to sign a loan contract, which the lender will send you. You will receive the funds after you've signed the loan contract.

Why compare personal loans with Finder?

Addicted to details. We know taking out a personal loan is something you'll be hooked up with for a while. That's why we put hours into research for this guide (and still do at least once a month)

Rates obsessed. Lenders come in all shapes and sizes, that's why we don't just track the big banks, but all the digi folk too. Pretty much everyone but your parents to be honest.

Cash for whatever you need. Lending rates verified from 180+ products day and night. Whether you're buying a car, rennovating your home or heck just ready to let loose with the spending - we got you.

Frequently asked questions about personal loans

• What's the difference between short term loans and personal loans?

  While a short term loan, also known as a payday loan, is a type of personal loan, there are a number of differences. Personal loans are generally taken out over 1 to 7 years, whereas a payday loan is between 16 days and 1 year. Payday loans are also for smaller amounts – up to $2,000 – and are available to those with bad credit.

• What if I'm rejected for a personal loan?

  Each lender has their own process and criteria, so if you're not approved for one loan, you can still apply for another. It's best to aim to meet the advertised criteria rather than apply for as many loans as possible, as too many applications can reflect poorly on your credit score, making it harder to get approved for future loans.

• I'm having trouble repaying my loan – what do I do?

  If you are having trouble repaying your loan, you'll need to get in contact with your lender. They may be able to organise a payment plan with you or be able to offer you some sort of option to help you manage your repayments. You also have the option of getting in touch with a free financial counsellor on 1800 007 007 to help you organise a budget.

• Can I use a personal loan to buy equipment for my business?

  Sometimes. Some lenders let you use a personal loan for business needs, from trucks to equipment. Check the lender's terms first, as some personal loans can only be used for personal purposes, and the responsible lending obligations don't apply to credit used wholly or predominantly for business purposes. A business loan may suit you better. Where the lender allows it, business vehicles including company cars, trucks or vans can be financed with a personal loan. If your business requires specific equipment to purchase, such as forklifts, earth-moving equipment, workshop machinery or even office equipment, you can take out a personal loan to help cover the costs. You won't have to hurt your business's cash flow to make the purchase.

Written by

Matt Corke

Head of Publishing Ventures

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Matt Corke is Finder’s head of publishing ventures. Prior to this he was head of publishing for Australia, New Zealand and emerging markets. Matt built his first website in 1999 and has been building computers since he was in his early teens. In that time, he has survived the dot-com crash and countless Google algorithm updates. See full bio