What Are Unsecured Loans?
Unsecured loans are often referred to as signature loans because that’s all that is needed if the borrower meets the requirements.
Note: Unsecured loans typically have higher interest rates as lenders take on more risk when approving a loan without assets for security.
When you take out an unsecured loan, there is no collateral protecting the loan so lenders have no legal right to any of your assets if you fail to pay.
How Unsecured Loans Work
When issuing unsecured loans, lenders carefully review your credit score and history, your employment and income, and your current debt-to-income ratio.
If any of these do not align with the bank’s requirements, you will not get the loan.
Some examples of unsecured personal loans include:
Unsecured loans generally have little paperwork and a short approval process. You also do not risk losing any property, as there is no collateral.
That said, these loan amounts are generally small, so the bank generally doesn’t stand to lose much if you default.
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Online unsecured loans are best for short-term emergencies and are not a solution to serious financial troubles.
Here are some of the advantages of unsecured loans:
- No collateral needed
- Quick access to funds
- Competitive rates for borrowers with good credit
- Less borrowing restrictions
On the downside, with unsecured loans, you run the risk of losing your assets. You may also have lower borrowing limits and higher interest rates if you have a low credit score, and there is typically a stricter approval process.
Secured vs Unsecured Loans
Secured loans differ from unsecured loans in that they require assets as security for the loan. Like secured credit cards, borrowers need to have collateral.
Getting approved for secured loans is often easier than unsecured loans because there is less risk to the lender. Interest rates are typically also lower.
How to Qualify for an Unsecured Loan
To limit risk, lenders typically want to make reasonably sure that you will be able to repay your loan. They may ask about the following information:
Lenders may review your credit report to see how you handle credit cards and manage your payments. They look for responsible credit use, timely payments, and low credit card balances.
They also check your credit score and borrowers with scores of 700 or more typically get the best interest rates.
Although unsecured loans do not require any assets, sometimes credits look at things like your savings. If you have significant savings it means that you are less likely to miss a loan payment.
If you have sufficient income to comfortably afford your monthly loan payments, you are less of a risk to a lender.
They also look at your debt-to-income (DTI) ratio. This is calculated by taking your monthly debt payments and dividing them by your gross monthly income.
For example, say you have $600 worth of debt payments and a gross income of $2,000 per month, your DTI would be 0.30 or 0.3%.
Lenders use this to determine your ability to repay a loan. The lower your ratio the better, and lenders typically don’t approve DTIs higher than 43%.
Financer.com compares the best non-secured loans from top lenders, helping you find a loan that suits your needs.
Unsecured Loan FAQs
What is an unsecured personal loan?
An unsecured loan is simply a personal loan that doesn’t require any collateral.
Why does an unsecured loan have a higher interest rate than a secured loan?
In short, lenders take on more risk with unsecured loans as they are not backed by collateral.
What happens if you don’t pay back a unsecured loan?
Most lenders charge hefty late penalties and if you’ve agreed to have your loan payments deducted automatically from your bank account, it will result in your account being overdrawn.
This will result in even more fees. If your loan remains unpaid for a few months, you may be handed over to a debt collector. If you still don’t make any payments or suitable payment arrangements, you may be summoned to appear in court.
If a judgement is issued against you it can remain on your credit report for up to 10 years.
Why are student loans considered unsecured?
There is often no collateral required for a student loan, which is why it falls under the unsecured loan category. However, when it comes to non-payment these loans are not always treated the same as other unsecured loans. Failure to pay a student loan can result in a judgement against the consumer and may also include the garnishment of wages.
What are the best unsecured loans?
This will depend on each borrower’s individual needs. Unsecured loans include personal loans, student loans, and personal lines of credit. Always compare loan rates to find the best loan offer from lenders.