Bank Loans: How They Work and How to Get Them

how bank loans work

Bank Loans: How They Work and How to Get Them

There are many reasons someone may be interested in bank loans. Perhaps they have an unexpected home repair that will cost thousands. Or maybe they need money to help their small business meet increased demand.

Whatever the reason for looking into bank loans, there are many banks and financial institutions that are happy to provide bank loans to qualified individuals.

Bank loans, as with most things in finance, are more complex than one might think. Oftentimes taking out a loan at a bank requires physically meeting with a representative. Representatives of small and mid-size banks are not always available at the most convenient times.

I will share some alternative options to traditional bank loans later on in the post, but first I would like to explain how they work and how to get them. In particular it’s important to understand terminology like “secured” and “unsecured,” as well as what interest rates to expect.

Secured versus Unsecured Loans

It’s essential that anyone thinking about looking into bank loans understand the difference between a secured loan versus an unsecured loan. This has a big impact on both how a loan is administered as well as how easy or difficult it is to qualify for one.

A secured loan is tied to a physical asset. Two simple examples of this are home and auto loans. A mortgage is tied to a home, which is why banks will not give out loans for more than what an appraiser values a home at (hence why an appraisal is typically required before closing on a home purchase). Bankers want to make sure that they will be able to recover the full loan value if the loan goes into default.

An auto loan is another great example of a secured loan. When an auto loan is taken out by a borrower, the lender holds the title until the loan is completely paid off. Holding the title prevents the customer from selling the car and taking the money without first paying back the loan.

Unsecured loans are not tied to physical assets. Many bank loans (or personal loans, small business loans, etc.) are unsecured and are given only to qualified borrowers.

Unsecured loans are riskier for banks because they are not tied to a physical asset, so credit rating is a big consideration when banks are deciding whether to give a personal loan. It will be much more difficult to get a personal loan if you have a low credit score because a bank will be taking on a higher risk of default and will have a more difficult time recovering the loan value, as opposed to a secured loan.

Likewise, if someone has a high credit score the bank is more likely to take on the risk of providing the borrower an unsecured loan.

What Interest Rate Should I Expect?

Interest rates for bank loans will vary based on a variety of factors. These include:

  • Credit rating of borrower
  • What the loan is being used for
  • Length of loan
  • Amount of loan

Auto and home loans typically have more standard interest rates than other types of loans. This is especially true of home loans.

The higher risk a loan is for the lender, the higher the interest rate will be for the borrower. There should be nothing surprising about this policy. As you can imagine, a $1,000 loan that has a 12 month term will be less risky than a $1,000 loan that has a 36 month term. After all, a lot can happen in those additional 24 months. Therefore the 12 month loan should have a lower interest rate than the 36 month loan.

Personal loan interest rates can vary greatly. People with excellent credit can get personal loans for as low as 1.99%, while those with very low credit scores may be facing interest rates in the 15-25% range. I will shed some more light on interest rates in the next section where I give actual companies you can visit to get interest rate quotes on unsecured personal loans.

How do I get a Bank Loan?

If you are looking to get a bank loan, virtually any bank or credit union will be able to help you. As I said earlier, taking out a loan typically requires sitting down with a bank representative who specializes in bank loans.

When I had an unexpected home repair that I thought was going to cost me nearly $10,000, I looked into getting a personal loan from the bank that I bank with. One thing that disappointed me was that their representative who worked on personal loans was only in their specific branch for three hours on Tuesdays and Thursdays. They required meeting in-person to initiate a loan, and the hours they were available were not great for someone who works at a 9-5 job.

While going to a physical bank and discussing bank loans is something I highly encourage people to do, there are other options that do not require physically meeting with a representative. If you are interested in convenience, though, the next three options may be good alternatives to “traditional” bank loans:

  • LightStreamLightStream is a division of SunTrust Bank and offers unsecured loans to people with excellent credit. The interest rates on their loans are between 1.99% and 9.99%. Everything with the loan is done online, and the application process is only two pages. Again, this is only for people with “excellent” credit.
  • ProsperProsper is a peer-to-peer lending company where people can both apply for personal loans. In peer-to-peer lending, people can invest in loans with different levels of risk. Prosper will offer loans for people with even the worst credit, granted the interest rate will be relatively high to compensate investors for the higher level of risk they are taking on. Loans start at an APR of 6.73%.
  • Lending ClubLending Club is another peer-to-peer lending company. They have loans with APRs starting at 6.48% and also will provide loans to people with even the lowest credit rating.

These are three convenient options for getting personal and business loans. There is no physical meeting – and in most cases not even a phone call – necessary to get set up with a loan. They offer a great alternative to “traditional” bank loans from brick-and-mortar institutions.

In an ideal situation everyone looking into bank loans would talk to someone at their local bank and credit union as well as check out all three of the sites I listed. There likely will be a difference in the interest rate quoted, so I’d encourage people to shop around as much as possible when they are in the market for a loan.

David Carlson works in finance and is a personal finance blogger at Young Adult Money.  You can find him on twitter @YoungAdultMoney or @DavidCarlson1.