How Do Bank Loans Work? (2024 Guide)

A bank loan is a personal loan that is borrowed directly from a bank or other financial institution. Bank loans can be secured loans or unsecured loans, though personal loans usually do not require any collateral. Each lender determines the borrower’s interest rate and will determine their own sets of terms and conditions. 

Borrowers will typically pay back the loan to the bank over a set amount of time and with a predetermined interest rate – and a monthly payment that does not change for as long as you have the loan.

Qualifying for a bank loan can be more difficult than other personal loans since banks often have more rigorous criteria for their borrowers.

Personal loans come in all shapes and sizes, each serving a slightly different purpose and consumer. Take a look at a few different personal loans and see how they stack up against bank loans.  

• Payday loans: Also known as cash advance loans, these are used to borrow small amounts of cash in a short time frame. These loans often come with high interest rates and fees and can quickly leave the borrower in a debt cycle. Bank loans are typically used for larger amounts of cash, intended to be paid back over a longer period of time.
• Peer-to-peer loans: These are private loans that are issued from one individual or group to another. Because these loans skip banks altogether, the terms for the loan can be quite a bit looser. Bank loans are issued through financial institutions, so the terms and conditions are more regulated.
• Online loans: In line with their name, online loans are handled almost entirely online. The lender, application and approval process are all completely virtual. These loans are typically unsecured and may come with lower interest rates because the online lenders don’t have the same overhead expenses as a brick-and-mortar institution.

Overall, bank loans have quite a few advantages over other types of personal loans. They often come with more favorable terms and if the borrower already has an account with the bank lending the money, they may be willing to offer a discount on the interest rate or associated fees.

Before applying for a bank loan, consider what you will use the money for. Often, borrowers use bank loans to fund large purchases such as a car, major home improvement projects, business ventures, etc. so the loan amount is larger than some other personal loans. 

Many borrowers use a bank loan for debt consolidation, trading multiple accounts for a single payment, potentially with a lower interest rate. This can prove helpful because it simplifies the payback process, and results in less interest being paid overall.

When you’re ready to apply for a bank loan, follow these steps.

1. Research lenders: Research multiple lenders to see which fits your specific needs. You can start by looking into your current bank, especially if they’ll offer you a discount, but don’t be afraid to branch out to other financial institutions. 
2. Prepare documentation: Once you have decided upon a bank lender, it’s time to take a look at the documents you will need to provide. It can take a few days to put these together, so give yourself time to gather the appropriate information. You’ll typically need to provide your social security number, proof of identity and proof of income via pay stubs or tax returns. 
3. Apply for the loan: Most banks have their bank loan applications available online, although you can generally go in person as well. The bank will likely look at your credit history as well as your debt-to-income ratio. Since banks have higher criteria for their loans, the approval process can take a bit of time. 

Before looking for lenders, it’s important to know your credit score. If your score is lower than 610, you may want to consider trying to raise it before you continue with your application process. Banks often look for borrowers with good credit scores and strong credit histories. 

If your credit score is low, you can consider getting a co-signer for your bank loan. If the co-signer has a higher credit score, this can increase your chances of getting approved. Be aware though that a co-signer is also assuming the responsibility of the loan, meaning that if the loan isn’t paid back on time, it can hurt the co-signer’s credit score.

Bank loans can be a great option for those looking to borrow a larger amount of money. But, as with any loan, there are advantages and potential drawbacks. Before deciding if a bank loan is right for you, let’s look at the pros and cons of these loans.

If a bank loan isn’t the right solution for your financial needs, there are a few alternative financing options such as credit cards, personal lines of credit and peer-to-peer lending platforms. 

Before taking the next steps on any of these alternate solutions, consider exactly what you want to accomplish with your loan. Consider how much money you’ll need, what repayment schedule is realistic for you and what you can qualify for with your credit score and history.

Managing loan repayments responsibly is crucial for your financial success. Without a proper repayment plan, it can be easy to get behind on monthly payments, which can lead to late-payment fees, mounting debt and a hit to your credit score. 

You can set yourself up for success by implementing a few practical repayment tips: 

• Set up automatic repayments: This ensures you will never miss a payment (assuming you always have the proper amount of money in your checking account). 
• Create a loan repayment schedule: This helps you see when your monthly payments are due, how long you will have between payments and how much you can expect to owe for each payment.
• Set up a budget: Using a spreadsheet or a budgeting app, input all of your monthly expenses (including your loan repayment) so you can see an overview of your monthly cash flow and ensure everything gets paid on time, every time.

Whether you’re planning to remodel your home or looking to consolidate your debt, a bank loan can provide a way to access the required cash. Before applying, learn how bank loans work, and how they differ from other personal loans and alternative financing options. 

Knowing the application process ahead of time can help you prepare your financial statements and improve your credit score, both of which can help improve your chances of approval. Carefully assess your financial situation and explore all of your options before you dive in.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.