How do personal loans work? Your questions answered

Thinking about a personal loan but don’t know much about the process or how to go about it?

Then read on, because here is pretty much everything you need to know about personal loans and how to get one. 

How does a personal loan work?

The basics are – You borrow a specified amount of money from a bank or another lender and you have an agreement to repay the money back over a set term.

Usually you’ll make your payments monthly (or fortnightly) and you can use the loan for a variety of purposes, such as a holiday, home improvements or extra vocational training.

The purpose of a personal loan is to fill a short or medium–term gap in your finances. If you need some extra training, for example, and you don’t really have time to save up for the fees, a loan can help you.

To get your loan, you have to apply to a lender who’ll use your information and credit rating  to see if you’re eligible for the finance.

Your repayments will start shortly after you receive the funds and each instalment will pay back part of the capital plus the interest generated on the loan to date. You make the repayments each month so that your loan is repaid by the end of the term.

Compare the loans on offer

Before you apply for a loan, you have to know what you’re applying for. You need to compare the loans that are on offer and are within your needs and means, so you should use a comparison site.

You need to look at the loan amounts, the payback periods (or terms), the establishment fees and, vitally, the interest rates and subsequent instalment amounts. It’s also important to find out if you’ll be penalised for early repayment on the loan.

Check your eligibility

Lenders have their own eligibility criteria when it comes to personal loans, so make sure you fit their minimum requirements. Before you dive in, ask, “how much can I borrow?” and use a personal loan calculator to do the maths yourself.

Then consider your: 

• Age: as most lenders want you to be at least 18, with some raising the bar to 21
• Income: you’ll need to be earning over a specified minimum amount in order to apply; you can verify this by payslips, bank statements or tax returns
• Your employment: most lenders need you to be employed and some want you to be past any probationary period in a relatively new job
• Your residency: you’ll need to be a citizen or permanent resident of Australia to be able to apply for a personal loan.

Just meeting the minimum requirements doesn’t mean you’ll be approved.

Lenders will look at your income, outgoings, any outstanding debts, your employment history and your credit history.

While there may be personal loan options out there for people with bad credit, you may have extra conditions attached to the agreement, or higher interest rates.

Make the application

Lenders all have their own slightly different application processes. Usually you’ll apply for personal loans online, over the phone or in–branch. Whichever lender you go with, they’ll want supporting documents, which include the following: 

• Proof of identity: like your passport or driver’s licence
• Proof of address: like a recent bank statement or a utility bill
• Proof of income: usually payslips or bank statements (covering at least three months), or two years of tax returns if you’re self-employed, and
• Credit card, store card or loan statements if you have any other debts.

If you make an application online it usually takes around 15 minutes from start to finish.

Wait for approval

Some lenders are able to approve you (or reject you) instantly, but others can take two days or more. You can get either full or conditional approval.

With conditional approval, while you may get this instantly, you’ll need to supply more documents, such as more payslips or other financial statements. Some lenders will ask for this information without offering conditional approval; they want all the information before making a final decision.

Once you’ve submitted all the information the lender needs, they’ll be in a better position to make a final decision, which may be full approval.

The loan funding

The way the loan is paid to you will depend on the sort of loan it is. If it’s a car loan, for example, your lender will probably pay the money directly to the dealer. It’s often the same with loans for debt consolidation; the lender transfers the money to your creditors instead of to you.

For most loans, especially unsecured personal loans, you’ll receive the funds into the account that you nominate. While some lenders can move the funds to you on the same day as you’re approved, others may need a few days after your approval.

Make repayments

You can probably choose which day of the month you make your repayments, so that you’re less likely to forget or be late. You can also ask to pay fortnightly, but as paying more frequent instalments means you pay less interest, your lender may charge a bit extra.

You can also find out if you can make additional repayments or even pay the loan off early to save money. Some lenders will apply an early repayment fee because they won’t be getting as much interest as they expected at the time of the initial agreement. You need to make sure that you’ll save more in interest than the cost of the early repayment fee.

Find out about repayment holidays

Some loan agreements include the option to take a repayment holiday. This may be at the start of the repayment term, or you may decide to take it over an expensive time of year like Christmas, for example. You need to remember that your loan balance will carry on accruing interest during this period, so your total repayment will be slightly higher.

Your loan closure

If you’re just following your loan’s terms and making the stipulated payments each month, your loan will be closed after your final instalment. It’s wise, if you’re planning to pay your loan off early, to call the lender and get a final settlement figure first (in writing). This means that you don’t get any surprise interest after you’ve made your closing payment.

Compare personal loans from Australia’s major banks, credit unions and other lenders at InfoChoice.

The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. If you or someone you know is in financial stress, contact the National Debt Helpline on 1800 007 007.