How Do Personal Loans Work in Australia?

What is a personal loan?

A personal loan is a lump sum of money that you borrow from a lender and repay over a fixed term, usually between one and seven years. You typically make regular repayments, often fortnightly or monthly, until the loan is paid off. Unlike a credit card, which provides ongoing revolving credit up to a limit, a personal loan gives you a single cash amount upfront, and you can use it for a variety of purposes such as buying a car, renovating your home, consolidating debts, or covering unexpected expenses.

In Australia, personal loans are offered by banks, credit unions, and non-bank lenders. They can be secured against an asset or unsecured, and the interest rate may be fixed or variable. Understanding these features helps you choose a loan that fits your financial situation and goals.

Sources: Australian Securities and Investments Commission (ASIC) - Moneysmart, Canstar, Pepper Money

How personal loans work: the borrower-lender relationship

When you take out a personal loan, you enter into a legally binding agreement with a lender. The lender provides the loan amount, and you agree to repay it, plus interest and any applicable fees, over the agreed term. The interest charged is calculated on the unpaid daily balance, based on the annual interest rate divided by 365 days. This means you pay interest only on the remaining amount you owe, so as you make repayments, the interest component decreases.

If the loan is secured against an asset, such as a car, the lender has the right to repossess and sell that asset if you default on the loan. For unsecured loans, there is no collateral, but the lender can still take legal action to recover the debt. In addition, lenders are required to make reasonable inquiries into your financial situation to ensure the loan is not unsuitable—this is part of responsible lending obligations in Australia.

Your credit history and income play a significant role in the approval decision and the interest rate you receive. Borrowers with better credit scores usually qualify for lower rates, while those with lower scores may face higher rates or may be declined.

Sources: ANZ, Sprintlaw, Pepper Money, Finder

personal loans: secured and unsecured

Personal loans fall into two main categories: secured and unsecured. A secured loan requires an asset, such as a car or other valuable property, as security. If you fail to make repayments, the lender may repossess and sell the asset to recover the debt. Because the lender has this added protection, secured loans often come with lower interest rates than unsecured loans. However, the risk is that you could lose the asset if you default.

An unsecured loan does not require any collateral. The lender relies on your creditworthiness and ability to repay. Since there is no asset backing the loan, the lender takes on more risk, and as a result, interest rates are often higher than those for secured loans. Unsecured loans are a common choice for borrowers who do not want to risk an asset or who do not own one suitable as security.

Within both categories, you can also choose between fixed-rate and variable-rate loans. With a fixed-rate loan, the interest rate and your repayments remain the same for the entire term, giving you certainty. With a variable-rate loan, the interest rate can go up or down, so your repayments may change over time.

Sources: Australian Securities and Investments Commission (ASIC) - Moneysmart, Sprintlaw, Bank Australia

Key features: interest rates, fees, terms, and repayment

Personal loans come with a set of features that determine the overall cost. The interest rate can be fixed or variable, and the rate you pay depends on factors such as your credit score, the loan type, and the lender. The comparison rate is a useful tool because it shows the true cost of the loan by combining the interest rate with most fees and charges, allowing you to compare different loan offers more easily.

Lenders may charge various fees, including establishment fees (a one-off cost to set up the loan), monthly or ongoing fees, late payment fees, and early repayment fees on fixed-rate loans. It is important to read the loan contract carefully to understand all applicable fees.

The loan term typically ranges from one to seven years. A longer term means lower monthly repayments, but you will pay more interest over the life of the loan. Conversely, a shorter term reduces total interest but increases the amount of each repayment. Your repayment schedule is usually fortnightly or monthly, and you can often make extra repayments, although some fixed-rate loans may charge a fee if you pay the loan off early.

• Interest calculated daily on the unpaid balance, charged at the end of the billing cycle.
• Comparison rate helps reveal the true cost including fees.
• Consider the total interest paid over the term, not just the monthly repayment.

Sources: ANZ, Australian Securities and Investments Commission (ASIC) - Moneysmart, Pepper Money

Personal loan vs credit card vs payday loan

Choosing between a personal loan, a credit card, or a payday loan depends on your borrowing needs and financial situation. Each option has distinct features and costs.

A personal loan provides a lump sum that is repaid over a fixed term, typically with lower interest rates than credit cards for larger purchases. A credit card offers an ongoing line of credit up to a set limit, allowing you to borrow up to that limit, make purchases, and revolve the balance, but standard credit card interest rates are often higher than personal loan rates. Payday loans are small, short-term loans, often up to $2,000, with high costs—in Australia, fees are capped by ASIC, including an establishment fee of up to 20% of the loan and a monthly fee of up to 4%.

For large, one-off expenses like buying a car or consolidating debts, a personal loan may be more cost-effective. For everyday purchases or flexible borrowing, a credit card may be convenient if you pay the balance in full each month to avoid interest. Payday loans should generally be considered only as a last resort due to their high costs.

Sources: Great Southern Bank, Fox Finance Group, Mozo, Savings.com.au

what to expect

Applying for a personal loan in Australia typically involves several steps. First, you need to choose a lender and submit an application, either online, in person, or over the phone. During the application, you will be asked to provide supporting documents, including proof of identity, proof of income, and bank statements. Self-employed applicants may need to provide additional documents such as tax returns.

The lender will then assess your application, making reasonable inquiries into your financial situation to ensure the loan is suitable for you. This includes checking your credit history and confirming your ability to make repayments. If approved, the lender will provide a loan agreement, and once you sign and any cooling-off period (if applicable) ends, the funds are usually transferred to your nominated account.

The exact timeline from application to funding varies by lender, but you can generally expect the process to take from a few hours to a few days. It is important to note that submitting multiple loan applications in a short period can negatively affect your credit score, as each application may result in a credit enquiry. To avoid multiple dents to your score, it is advisable to research and compare loan options before applying.

• Prepare documents: proof of identity, proof of income, bank statements.
• For self-employed: tax returns or additional financial statements.
• Each application may trigger a credit enquiry, which can affect your credit score.

Sources: Pepper Money, ANZ

Common uses for personal loans

Australians take out personal loans for a wide range of purposes. According to Money.com.au data, the most common reasons include vehicle purchase (45% of loans), debt consolidation (29%), and home improvement (9%). Other frequent uses include medical expenses, education, travel, and weddings.

Using a personal loan to consolidate higher-interest debts, such as credit card balances, can potentially lower your overall interest costs and simplify your finances by combining multiple repayments into one. However, it is important to consider the fees and the term of the new loan to ensure it actually saves you money.

Sources: Money.com.au, Bank Australia

Pros and cons of personal loans

Personal loans offer several advantages, including predictable repayments that can make budgeting easier, and the discipline of a fixed repayment schedule, which can help you pay off debt systematically. They may also offer lower interest rates than credit cards for significant purchases, and they provide a lump sum up front, which can be useful for large expenses.

However, there are drawbacks to consider. Unlike credit cards, you cannot borrow more once the loan is paid down without applying for a new loan. Personal loans may also charge various fees, and if you choose a secured loan, you risk losing the asset if you fail to make payments. Fixed-rate loans may incur penalties for early repayment, and variable-rate loans can see your repayments increase if interest rates rise, only if you have a variable rate.

It is crucial to weigh these pros and cons against your financial circumstances and goals before committing to a personal loan.

Sources: Great Southern Bank, Fox Finance Group, Mozo

Side-by-side category and decision-criteria matrix

To help you decide which borrowing option suits your needs, the table below compares personal loans, credit cards, and payday loans across common criteria.

Sources: Great Southern Bank, Mozo, Fox Finance Group, Savings.com.au