What Is a Personal Loan?

A personal loan is unsecured financing given to an individual by a bank, credit union or private lender. Relative to secured financing, such as a home equity or auto loan, a personal loan is less risky for the borrower, but a bit more expensive.

Obtaining a Personal Loan

You apply for a personal loan from a bank or lender. In some cases, lenders solicit consumers who they identify as good candidates for such financing. The two primary factors included in a personal loan approval decision are your credit rating and employment data, according to TESCO.

When you secure financing with collateral, the lender relies more on the value of your property in making the decision. Since there is no collateral with a personal loan, the lender wants to see that you have the income to make payments and the responsible credit history to suggest that you will meet your obligations.

Personal Loan Benefits

The fact that you don't have to expose personal property to repossession is a major advantage of a personal loan, according to Wells Fargo. If you default, your credit rating takes a hit, but you don't sacrifice a home or car.

Personal loans also don't typically have the upfront closing costs or origination fees that some types of secured loans do. For borrowers with a strong credit history, personal loan interest rates are often a few percentage points below what you pay on a credit card. Therefore, some use this type of financing for debt consolidation. Predictable interest rates and monthly payments also make budgeting for the loan simple.

Personal Loan Drawbacks

A primary drawback of personal loans relative to secured loans is that you don't get the same low interest rate. Since lenders take on greater risk by not requiring collateral, your fees are greater. Whereas a home equity loan might have an interest rate of 4.5 percent, a personal loan might cost you 7.9 percent depending on your credit rating.

The requirement that you have a decent credit rating to obtain a personal loan is a hindrance for people with lower credit scores. This restriction makes it difficult for someone drowning in debt to consolidate with this loan type.