How Do Bank Loans Work? Types, Requirements and Approval Tips
A bank loan is when you borrow a sum of money from a financial institution. You agree to repay the loan in fixed payments (principal and interest) during a specific time period. Here’s a five-step overview of how it works:
You apply for the loan. You submit an application with your identity, debt and income information.
The financial institution reviews the loan. The bank or credit union will take a look at your creditworthiness.
The bank approves the loan. The bank will release a lump sum payment.
You repay the loan. You repay the loan with principal and interest.
The loan is completed. Once the last payment is made, the loan closes.
Eligibility Ranges:
Credit score: The range typically is 580 to 740 or more.
Debt-to-income (DTI) ratio: The DTI is usually under 36%.
Key Takeaways
Bank loans follow a standard process. You apply, get reviewed for creditworthiness, receive a lump sum if approved and repay with principal and interest over a set term. Most lenders want a credit score of 580 to 740 and a debt-to-income ratio under 36%.
Loan type shapes your rate and risk. Secured loans like mortgages, auto loans and home equity loans offer lower rates starting around 5% to 10% but put your collateral on the line. Unsecured options like personal and private student loans run 8% to 36% and rely on your credit.
Run the numbers before you apply. Check your credit report, pay down existing balances to lower your DTI, prequalify with multiple lenders and review the APR, origination fees and prepayment penalties before signing.
Summary generated by AI, verified by MoneyLion editors
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How the Bank Loan Process Works
The bank loan process is straightforward. Here's how it works:
Check your credit and budget. Determine your credit score. You can pull your credit report from all three agencies once a year. This should take 10 to 15 minutes. Also, estimate your current budget to see if it’s practical to take on a loan.
Compare lenders and prequalify. You can shop around and see what rate you'll prequalify for. You'll need your Social Security number, estimated income and your loan amount. It may take 10 to 15 minutes to prequalify for your loan.
Gather your documents. Gather your ID, your pay stubs and your bank account login. Depending on how accessible your pay stubs are, this step should take 15 to 30 minutes.
Submit your application. You can submit your application to your lender. They'll pull your credit, and some lenders may charge an application fee. This process should take 15 to 20 minutes.
Review and accept your loan. Review your APR, monthly payment and total interest. Check if there's an origination fee. This process should take 10 to 15 minutes.
Get your funds. This should take one to two business days once you've provided bank account information.
Types of Bank Loans
Take a look at some of the most common types of bank loans below:
Loan Type | Secured or Unsecured | Best For | Typical APR Range | Term Length | When It Makes Sense |
|---|---|---|---|---|---|
Personal loan | Unsecured | Debt consolidation, medical bills | 8% to 36% | 1 to 7 years | You need fast cash without collateral. |
Auto loan | Secured | Buying a vehicle | 5% to 14% | 2 to 7 years | The rate is lower and tied to the car. |
Mortgage | Secured | Buying a home | 5.8% to 7.5% | 15 to 30 years | You're purchasing property long term. |
Home equity loan | Secured | Home improvements | 7.5% to 10% | 5 to 20 years | You have equity and want a lower rate. |
Business loan | Both | Business expenses | 7.5% to 17.5% | 1 to 10 years | The return outweighs the borrowing cost. |
Private student loan | Unsecured | Education costs | 4.5% to 16% | 5 to 15 years | You've used federal aid first. |
Personal Loans
The funds from a personal loan can be used to cover almost any purchase. You might use the funds for debt consolidation, medical bills, home repairs, celebration expenses and more. Although many personal loans are unsecured, some personal loans require collateral.
Auto Loans
An auto loan can be used to purchase a vehicle. Typically, an auto loan is secured by the vehicle you purchase with the funds.
Mortgage Loans
Banks offer mortgage loans to help a borrower pay for a home purchase. Typically, these large loans come with loan repayment terms of 15 to 30 years with either fixed or adjustable interest rates. Your home serves as the underlying collateral, which means if you cannot keep up with the mortgage payments, the bank might foreclose on your property.
Business Loans
Many banks offer business loans to both small and large businesses for any number of business expenses. Depending on the situation, the loan might be secured by business assets or unsecured.
Student Loans
Some banks offer private student loans to help students pay for educational expenses, like tuition, books and living expenses. Unlike federal student loans, private student loans don't offer attractive borrower protections, like student loan forgiveness or income-based repayment options.
Home Equity Loan
These types of loans are a secured way to get financing for expenses like home improvements. You can get much lower rates than an unsecured personal loan and use your home as collateral.
How the Bank Loan Process Works
Although the specifics of obtaining a bank loan vary slightly from one financial institution to another, the overall process tends to look similar. Below is a look at how the process usually works:
Loan application. The process starts when you submit a loan application. Be prepared to share information about your income, employment, credit history and loan purpose.
Credit evaluation. Banks will review your situation, including looking at your credit score, financial history and debt-to-income ratio.
Loan approval or denial. Depending on the bank's evaluation of your application, they'll approve or deny the loan request. Alternatively, the bank might request more information about your situation.
Loan terms and agreement. If you're approved for the loan, the bank will send over documents outlining the loan terms, interest rates, repayment period and fees. It's important to carefully review this information to confirm you are comfortable with the details of the loan before moving forward.
Loan disbursement. If you accept the loan, the funds might be disbursed as a lump sum or line of credit.
Loan repayment. Once you receive the loan, you'll start making payments based on your loan terms. In many cases, you might make regular monthly payments of principal and interest. If you want to repay the loan early, that's often an option. But check into prepayment penalties before moving forward.
Before starting the process with any particular bank, it's a good idea to shop around to find out which bank offers the lowest interest rates and fees.
Secured vs. Unsecured Loans
Loans can be secured — attached to collateral like a car — or unsecured. When you have a secured loan, the lender can seize the asset if you don't keep up with your scheduled payments.
The table below outlines the differences between secured and unsecured loans.
Feature | Secured Loan | Unsecured Loan |
|---|---|---|
Examples of collateral | Vehicle, house, savings | None |
Easier to get approved for | Easier — since collateral is offered | Harder — lender is taking more of a risk |
How rates compare | Lower — starts at 5% to 10% | Higher — 8% to 36% |
What happens if you can't repay | You lose your collateral | Late fees, negative impact to your credit and possible collections if unpaid |
Best for | Those who have lower credit scores | Those who have good to excellent credit |
Tip: Secured loans usually have lower rates, but your collateral is at risk.
Unsecured loans are easier, but often cost more.
Factors That Affect Loan Approval
When it comes to getting approved for a bank loan, many factors come into play. Below is a look at some of the most important factors:
Credit score: Typically, borrowers with higher credit scores enjoy lower interest rates and better approval chances.
Income and employment: Most lenders prefer to work with borrowers who have stable incomes to support loan repayment.
Debt-to-income ratio (DTI): Your DTI reflects how much of your monthly income is consumed by your current debts. Ideally you want a DTI lower than 36%. In general, a lower DTI indicates more bandwidth to repay the loan. The formula for DTI is monthly debt ÷ monthly income. If you pay $1,500 in debt each month and earn $4,500, your DTI is 33%.
Collateral: Depending on the loan, you may or may not need to provide collateral. Typically, providing collateral leads to better approval odds.
How To Improve Your Chances Before Applying
You should pay down your credit cards as much as you can. It will lower your DTI.
Don't take on new debt. This will cause your credit score to dip.
Look into consolidating high-interest debt. Lowering your interest rate on existing debt can help you in the long term.
Increase income if possible. If you can find a side hustle to earn money, this could help your DTI.
How Much Your Loan Actually Costs
If you have a $10,000 loan with a 12% APR for 36 months, how much would it cost?
Monthly payment: ≈ $332
Total interest paid: ≈ $1,950
Total repayment: ≈ $11,950
What if you added a 5% origination fee to the same loan?
Fee amount: $500
You may receive $9,500, but you'll still repay $10,000
Effective total cost: $2,450 (interest + fee)
How much will you save if you pay the loan off early, if allowed? If there are no prepayment penalties and you pay the loan off in 24 months instead of 36 months, you’ll pay $1,250 in interest and have a savings of $700.
Is a Bank Loan Right for You?
Whether or not a bank loan is right for you depends on your situation. Before applying to a bank loan, do your research and assess your budget to confirm you can support the ongoing payment. If you can afford the payments and the loan fits into your long-term financial goals, then a bank loan might be right for you. If you aren't sure how you'd swing the monthly payment, then a bank loan might not be right for you.
FAQs
What credit score is needed for a bank loan?
The credit score you need depends on the loan you're applying for. For example, a personal loan generally requires at least a 580 credit score, but to avoid much higher rates, 670 is ideal.
How long does it take to get approved for a bank loan?
Depending on the situation, it might take a couple of hours or several weeks to get approved for a loan.
Can I get a bank loan with bad credit?
Some banks work with borrowers who have bad credit. But others won't. If you want to get a bank loan with bad credit, shop around to find a lender willing to work with you.
What is the difference between a fixed and variable interest rate?
A fixed interest rate remains the same over the life of the loan. A variable interest rate can change over the life of the loan.
Are there penalties for paying off a bank loan early?
Some banks impose prepayment penalties on borrowers who repay their loans ahead of schedule. Others don't. Read the fine print of a loan document before signing to find out about potential prepayment penalties.
What documents do banks require?
You need to provide proof of identity, pay stubs and tax information for your loan.
How fast can you get a bank loan?
The speed of the funding depends on the type of loan. A personal loan may take one to two business days, while an auto loan may take one day for funding. A mortgage loan could take much longer — somewhere between 30 to 45 days.
What fees should you expect?
You can expect origination fees, late fees and in some cases, an application fee.
Key Terms
Annual percentage rate (APR): APR is the yearly cost of borrowing money, including interest and some loan fees, shown as a percentage.
Debt-to-income ratio (DTI): DTI compares your monthly debt payments to your gross monthly income to show how much of your income already goes to debt.
Collateral: Collateral is something you own, like a car or house, that secures a loan and can be taken by the lender if you don’t repay.
Secured loan: A secured loan is backed by collateral, which can help you qualify for a lower rate but puts your asset at risk.
Origination fee: An origination fee is an upfront charge some lenders take from your loan amount for processing and funding the loan.
Sources:
Consumer Financial Protection Bureau:
Consumer Financial Protection Bureau:
Consumer Financial Protection Bureau:
Consumer Financial Protection Bureau:
Summary generated by AI, verified by MoneyLion editors
Sarah Sharkey contributed to the reporting for this article.
Photo Credit: Rob Daly / Getty Images
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