How do loans work?

Bank loans work similarly to loans from other lenders, but often require good or excellent credit to qualify.

Annie Millerbernd Published on 17 May 2021. Last updated on 19 July 2021.
How do loans work?

Bank loans work the same as personal loans you get from online lenders: After you apply, the bank will review your credit score, history and income to determine how much money to loan you and what annual percentage rate (APR) you qualify for.

Once you get the loan, you’ll pay it back in monthly installments. Typically bank loan repayment terms range from about one to seven years.

Be sure to compare bank loan offers before you apply to get the best rate you qualify for.

» MORE: Compare loans

Who can get a loan from a bank?

Some banks offer personal loans only to their existing customers. Others will accept loan applications from anyone. If you already have an account and are in good standing with a bank, you may receive a lower APR or added features, like a rate discount, on a bank loan.

Banks typically require a borrower to have a good or excellent credit score, credit history and a low debt-to-income ratio to take out a personal loan. If you don’t think you’ll qualify for a bank loan, look for ways to improve your credit or consider a guarantor or secured loan.

Credit union loans often have similar features as bank loans, like low interest rates and flexible repayment terms, but can be an option for people with fair and poor credit scores.

Uses for a bank loan

Bank loans can be used for almost any reason. Common uses include home improvement projects and debt consolidation. Some lenders allow you to use a personal loan to refinance an existing loan. Refinancing can make sense if the new loan has a lower rate than the loan you already have.

» MORE: How to choose a personal loan

Is getting a personal loan a good idea?

Depending on what you plan to use it for, a personal loan could be a good idea if it can help you reach your financial goals without putting you in financial jeopardy. It can also build your credit history, provided you make payments on time.

» MORE: What happens if you default on your loan

Having different types of credit — including revolving credit like credit cards, as well as instalment accounts like personal loans — can boost your perceived creditworthiness in the eyes of lenders.

» MORE: Credit card, loan or overdraft? Which is right for me?

How can I improve my chances of getting approved?

If you’re worried your credit score is too low to get the loan you want, there are a few steps you can take to help you get a personal loan:

  • Check your credit report regularly. You can get your credit reports for free at Experian, Equifax or TransUnion. If you see any errors on your reports, dispute them in writing or by phone.
  • Be consistent about making on-time payments toward all of your debts. This will help improve your debt-to-income ratio as well as build up your payment history, all of which impact your credit score.
  • Apply only for the amount of money that you need. Requesting more than you need means you’ll be making higher loan payments each month, which can jeopardize your budget and ability to pay your debts.
  • Consider finding a guarantor. If you don’t think you’ll be approved for the loan you want from the lender of your choice, adding a guarantor with a higher credit score and income can boost your approval chances.

Applying for a loan from a bank

Some banks allow you to use an eligibility checker to find out how much you can borrow and what rate you qualify for. This is a good idea as submitting an application triggers a hard credit check which could have a negative impact on your score.

» MORE: Eligibility check with NerdWallet

Once you’ve compared banks and decided which you’d like to borrow from, you’ll fill out an application. Some banks require an in-person visit to apply or close a personal loan.

Source: Getty Images

About the author:

Annie is a personal loans writer at NerdWallet. She previously worked as a content strategist for USAA and as a data reporter for the San Antonio Express-News. Read more

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