How Does a Bank Loan Work?

If you’re not sure how bank loans work, we’ve got some answers for you. Most of the personal loans on the market are known as installment loans, which means that your loan is usually given to you in one lump sum and is repaid over time, or in regularly scheduled installments. Installment loans are different from revolving loans, such as a credit card or line of credit, which have a credit limit on the amount that you can borrow at any one time. As you make payments towards your revolving credit debt, you can free up money to borrow again in the future up to your credit limit.

We’ll take a deeper look at installment loans and what you need to know about applying for a bank loan. While every bank has its own way of doing things, there are some basic features that many personal installment loans have in common.


How to Apply for a Bank Loan

The very first step is filling out an application. Sometimes you have the option of applying in person, online, or over the phone. Before you apply, check that you meet the eligibility requirements. Some banks have applicant guidelines such as these:

  • Must hold an account at that bank
  • Must be 18 or older and a U.S. citizen or resident
  • Must meet a minimum annual income

Your credit history will also play a role in the bank’s decision to extend credit to you, and may affect your loan’s APR. APR stands for “annual percentage rate,” and is an indication of how much the bank is charging you in interest. In general, the better your credit, the lower your interest rate. Commonly, when you apply for a loan, you can choose how much you want to borrow and how many months or years you would like to repay for. Some banks may advertise a minimum repayment period of a year or more, but you may be allowed to pay off a loan early without penalty.


Interest Rates and Repayment Schedules

After you’ve applied, the bank will review your information. If your application is accepted, they will quote you an interest rate before you sign the loan agreement. All banks post a representative APR on their websites, but not every applicant qualifies for that exact rate. Once you know the interest rate you qualify for, it’s a good idea to plug it into a loan calculator (many banks have them available on their websites) to make sure the total cost of credit is affordable for you.

Personal loans typically have a fixed repayment schedule, so you can easily evaluate whether you can work the monthly repayments into your budget. If you agree to the terms the bank offers you, the next step is to sign the loan agreement. Afterwards, the bank will pay you the agreed-upon loan amount in one lump sum, and you will make the agreed-upon repayments.


The many faces of borrowing

There are many types of bank loans available. Most personal loans are unsecured, so they are not backed by your personal assets. This generally makes them riskier for the lender. As a result, unsecured loans tend to have higher interest rates. Secured loans, on the other hand, are backed by your assets, like your car or home. They are less of a risk for lenders, but borrowers run the risk of having their property repossessed if they are unable to make repayments.

Sometimes, borrowers may not meet all application criteria to take out a bank loan, or they may need money more urgently than a bank can fund a loan. Other sources of loans include online lenders and credit unions.

In short, there are lots of borrowing options out there, which means you have the freedom to do some comparison shopping to find the loan you’re looking for at the best price.


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Written by:

Barbara Davidson

Babs is Lead Content Strategist and financial guru. She loves exploring fresh ways to save more and enjoy life on a budget! When she’s not writing, you’ll find her binge-watching musicals, reading in the (sporadic) Chicago sunshine and discovering great new places to eat. Accio, tacos! 

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