Trying to understand what to know before you apply for a personal loan? You’re wise to spend some time researching the topic before jumping in. There are many lenders out there willing to let you borrow money, but you should understand how personal loans work before applying.

What is a Personal Loan?

When you need money for a house you apply for a mortgage. When you want money for a car, you use an auto loan. But when you are interested in borrowing money for remodeling, debt consolidation, travel or other expenses, a personal loan is often the answer.

Personal loans are similar to mortgages and auto loans in that you’re borrowing a set amount of money and you’re making regular payments on that loan to pay it back. This is a very different payment structure than a credit card, which requires monthly payments but continually calculates interest on the loan. A personal loan will be a set amount borrowed with set monthly payments. When you’ve made the payments, you’ve repaid the loan.

Understanding Personal Loan Terms

Vocabulary falls into what to know before you apply for a personal loan. You want to understand the various terms that are being thrown around as you prepare to apply. Some of the most common personal loan terms include:

• Principal. The principal is the amount you’re actually borrowing. You might apply for a $10,000 personal loan. The principal of that loan is $10,000.
• Interest. The bank will charge you interest on your personal loan. This is how the bank makes money on the loan and how they balance the risk they are taking by loaning money in the first place. Every month you will repay some of the loan principal and some interest in your monthly payment.
• APR. The APR is the Annual Percentage Rate of your loan. The APR is a number that combines the interest rate and the fees the lender might charge for the loan. When you’re looking at how much a loan will cost, you should be looking at the total APR of the loan.
• Term or Payment term. The term of the loan is how long it lasts. You might borrow $10,000 and agree to pay it back in 36 months, 48 months or 60 months. The longer the term, the smaller your monthly payment, but the higher the interest rate. With a longer term you’ll pay less every month, but you’ll pay more over the life of the loan.
• Monthly payment. You’ll make a monthly payment every month after you’ve taken out the loan. Your monthly payment will be a combination of principal to repay the original loan amount and interest.
• Unsecured loan. A secured loan is a loan backed by something you buy. A car loan is backed by the vehicle, for example. A personal loan, on the other hand, is not backed by the item you’re buying. The bank can’t repossess a medical procedure you’re paying for with the loan proceeds, so the loan is considered unsecured.

Applying for a Personal Loan 

The process for applying for a personal loan is straightforward, but is essential for what to know before you apply for a personal loan. The steps you’ll take to apply for a personal loan include:

1. Locate all important information. This includes your social security number, income information, and bank account numbers.
2. Check your credit. Lenders are going to check your credit as a part of the process. Since this is part of what to know before you apply for a personal loan, you should check your credit first. Do a soft inquiry into your credit using a bank or personal finance app so that you’re not surprised by what you find.
3. Consider your Debt-to-Income ratio. The more debt you have, the less likely you are to be approved to take on more. Your debt-to-income ratio, or DTI is a simple mathematical equation. Add up the monthly debt you already have including a mortgage, car payment, student loans and credit cards. Divide that number by your gross monthly income. The result is your DTI. Convert the decimal to a percentage and check to see how close it is to 43%. If it’s over 43%, lenders may not consider you a good applicant for a loan.
4. Choose a lender. You can apply for a personal loan through a bank, a credit union, a peer-to-peer lending site or an online lender. Different institutions will have different requirements for credit scores and payment terms. Usually traditional banks have the highest requirements for credit scores and peer-to-peer or online lenders have the most flexibility for personal loans.

You should manage all types of credit wisely, including personal loans. A personal loan can lighten your financial situation in plenty of ways, but it is not something you should apply for on a whim. Consider your financial situation and how you plan to use the loan as you consider what to know before you apply for an unsecured personal loan.