How do personal loans work

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how do personal loans work


How do personal loans work?

In a personal loan, you borrow a sum of money to pay for a personal expense, then pay back this loan plus interest over time in a series of scheduled repayments.   

Do personal loans work like home loans?

Personal loans work similarly to mortgages, in that they require the borrower to commit to making regular repayments over the loan term, and make steady progress towards paying back their debt plus interest.

However, personal loans tend to have shorter loan terms than home loans. Paying for your home or investment property often takes decades (25 to 30 years or more is common), while many personal loans are repaid much sooner. Some personal loans can run for a few years (often between one and five years), while others have terms of less than 12 months.  

Do personal loans work like credit cards?

Most personal loans don’t work like credit cards. Here’s why:

If you have a personal loan…

  • You borrow a set amount of money, which you receive in one lump sum at the start of the loan, and can’t borrow more later on.
  • You are required to make regular repayments to make progress towards clearing your debt plus interest over time.
  • You are charged interest on what you owe when you make each repayment.
  • You can’t borrow more money later on as part of the same personal loan.

If you have a credit card...

  • You can borrow any amount of money, up to your credit limit, at any time.
  • You’re required to make regular minimum repayments (often very small ones), but aren’t required to completely clear your debt.
  • Most credit cards have a number of interest-free days for new purchases – if you clear your balance before these days expire each repayment cycle (often monthly), you aren’t charged interest on what you owe.

How do Line of Credit Personal Loans work?

While many personal loans let you borrow money in one lump sum, some personal loans offer a flexible line of credit, which functions much like a credit card with a higher than average credit limit.

Borrowers often apply for line of credit personal loans if they require flexible access to finance to manage multiple smaller expenses over time, rather than one large lump sum.

While you’ll only be charged interest on what you borrow, rather than the full lump sum, there may be fees and charges involved, and much like a credit card, you may be tempted to spend more than you can easily afford to repay.

How do secured and unsecured personal loans work?

Secured personal loans are guaranteed by the value of an asset, such as a car or equity in a property. If you’re unable to pay back your loan and default on your repayments, your lender will be able to repossess and sell your asset to help cover their losses. Because this makes lending money less risky for the lender, secured personal loans often have lower interest rates.

Unsecured personal loans don’t require security, making them a potential option for borrowers unable or unwilling to provide an asset as collateral. However, they often have higher interest rates on average.

Do car loans work like personal loans?

Most car loans are a type of personal loan, structured specifically for vehicle finance.

It’s common for a car loan to be a secured personal loan, using the value of the vehicle you’re purchasing to guarantee the loan, which can help you enjoy a lower interest rate. Because secured loans often require the vehicle to retain enough value to cover the loan, they may be restricted to particular vehicle models, or vehicles under a certain age.

If you’re buying a car that doesn’t suit a secured car loan, there are also unsecured car loan, which offer greater flexibility but often have higher interest rates.

How do personal loan features work?

  • Advertised rate – The interest you’ll pay on your loan
  • Comparison rate – An indication of the loan’s total cost, including the interest and the standard fees and charges.
  • Fixed rate – An interest rate that remains the same for the loan’s full term. Keeps repayments the same, for simpler budgeting.
  • Variable rate – An interest rate that the lender may increase or decrease during your loan term. You may save money if the interest rate falls and your repayments decrease, though your loan may cost you more if the interest rate rises and your repayments increase.
  • Redraw facility – If you make extra repayments onto your personal loan, you can redraw these from your loan if you need some of that money back again.
  • Fully drawn advance – A loan where you receive he full lump sum at the start of the loan term.
  • Early exit penalty fee – A fee that some lenders require the borrower to pay if they make enough extra repayments onto their loan to clear their debt ahead of schedule. 

How does applying for a personal loan work?

  1. Compare personal loans based on your personal finances: Make sure you’re confident you can afford to repay a personal loan before you apply, and that its feature and benefits are suitable for your households’ needs.
  2. Check your eligibility: Most personal loans require you to be an Australian resident who’s over 18, has a steady income, and a good credit score. Some loans and lenders have more or less requirements – check before you apply.
  3. Collect your documents: You’ll usually need to provide ID and enough documentation to prove you fulfil the loan’s eligibility criteria.
  4. Apply, either online or by completing a paper application form: Your lender may take less than an hour to assess and approve your loan, or it may take a few business days, depending on your lender.
  5. Get your money: You may receive your funds on the same day of your loan’s approval, or it may take a few business days.
  6. Start making repayments: You may be able to pay monthly, fortnightly or weekly, which may better suit your income. Also, making extra repayments may help you clear the loan faster and pay less interest.

How do debt consolidation loans work?

If you have outstanding personal loans and/or unpaid credit cards, and are struggling to keep up with your payments, one option could be to apply for a debt consolidation loan. These personal loans let you borrow enough money to clear your other outstanding debts, effectively exchanging multiple smaller debts for a single combined debt. This means you’ll have just one loan repayment to manage, and you’ll only be charged interest on one loan, and at one rate.

Debt consolidation personal loans may not be suitable for every financial situation. Consider contacting a financial adviser before applying. The national debt helpline is another resource available to borrowers struggling with outstanding debts.


^Words such as "top", "best", "cheapest" or "lowest" are not a recommendation or rating of products. This page compares a range of products from selected providers and not all products or providers are included in the comparison. There is no such thing as a 'one- size-fits-all' financial product. The best loan, credit card, superannuation account or bank account for you might not be the best choice for someone else. Before selecting any financial product you should read the fine print carefully, including the product disclosure statement, fact sheet or terms and conditions document and obtain professional financial advice on whether a product is right for you and your finances.

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