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What is an unsecured personal loan?

Yahoo Personal Finance· Getty Images
6 min read

An unsecured personal loan is issued by a lender without requiring you, the borrower, to provide anything of value to guarantee it. Like a credit card, you qualify for a personal installment loan strictly on your ability to repay the borrowed amount.

Sounds good, doesn't it? Here's what you need to know.

Borrowers can apply with any financial provider, such as a bank, credit union, or online lender, for a lump sum of money. Personal loan amounts may be hundreds or thousands of dollars — but borrow only what you need, even if the lender offers to approve you for more. That way you don't dig yourself into a deeper debt hole.

To be approved, you'll need a good credit score, a steady monthly income, and a history of reliable repayments. Lenders will likely also consider your existing debt obligations as measured by your debt-to-income ratio (DTI) and recent inquiries on your credit report.

The lender will determine an interest rate based on your creditworthiness, as revealed in your loan application, and you will make monthly payments for a predetermined time to repay the loan. The loan terms can typically range from one to five years, sometimes longer. Of course, the longer your repayment period, the more interest you'll owe.

The interest rate is key to snagging the best personal loan. Say you're considering a $10,000 loan for 36 months at 18% interest. The total interest paid would amount to over $3,000. However, qualify for a loan rate at 12% interest, and you would pay a little under $2,000 in interest over the life of the loan.

Your FICO credit score can earn you a lower interest rate. Excellent credit can be the difference between a 12% rate — the median rate for a credit score in the range of 720-850 — to over 18% for borrowers with a credit score from 630 to 689, according to Bankrate research.

Interest rates vary significantly among lenders, and some will tack on additional fees, such as application, origination, document fees or prepayment penalties. You'll want to shop around for the best interest rate and repayment terms, along with the lowest fees you can find.

A secured personal loan is the exact opposite of an unsecured loan. Something of value is required to serve as collateral for the lender. With that added security, a secured loan may have a lower interest rate and can be easier to qualify for than an unsecured personal loan. The lender believes you will want to keep ownership of whatever is being held to guarantee the loan, whether a vehicle, your house, a savings account, jewelry, or other property.

On the other hand, an unsecured loan is bound only by your signature and a promise to pay. There is nothing at risk of being repossessed if you default on the loan. Of course, your credit score will be impacted, and debt collectors may hound you if you don't repay the loan.

Since the lender is taking on more risk, an unsecured loan will likely have a higher interest rate and may be harder to qualify for.

  • Your credit history can be all you need to qualify. You're not putting anything of value at risk of repossession.

  • The loan application process is typically uncomplicated.

  • You'll likely be able to choose your repayment terms, which impacts your monthly payments. It feels good to eliminate debt sooner rather than later.

  • With good credit, interest rates are typically lower than putting a big-ticket item on a credit card.

  • It often doesn't take long to get the lump sum of money in your hands — often just a few days or so.

  • You can use the loan proceeds for just about anything you want.

  • You will likely pay a higher interest rate than with a secured loan.

  • Some lenders will pad their profit with additional charges, such as an origination fee or prepayment penalty.

  • Secured loans might qualify you for higher cash amounts.

Choosing the most suitable loan for you can be a matter of 1) your credit score, 2) other financing options you may have, and 3) if you have property without a prior lien available to use as collateral. Excellent credit and a higher credit score will earn you the best loan rates.

Getting a mortgage to buy a home or a vehicle loan for a car are examples of secured loans.

Determine the amount you would like to borrow for the monthly payments you can afford. Use a personal loan calculator to work the numbers.

Consider several lenders of all different kinds: large, small, online or on a nearby corner. Eligibility requirements vary widely, so you want to get multiple loan offers.

Compare interest rates, fees, and loan terms. A fixed interest rate is often the best choice.

See if you can prequalify with a lender or two without impacting your credit score. Look for lenders with competitive rates that promise a "soft" credit inquiry for a prequalification rather than a "hard" credit check.

Gather your documents such as ID, Social Security number, proof of income (pay stubs or bank statements), proof of residence, etc. The lender may ask for other documentation, as well.

Choose the best personal loan offer and submit an application.

If you're confident you can repay the loan, yes. You can put your credit reputation at risk by taking on too much debt, but if a new personal loan is within your ability to repay it can be a fine financing alternative. And with an unsecured personal loan, no property is at risk. However, if you fall behind on payments, debt collectors can be relentless in their efforts to get paid — and might even garnish your wages.

Student loans and credit cards are two types of unsecured loans. Sometimes unsecured debt is called a "signature" loan.

A credit score of 580 is typically required to qualify for a personal loan, according to PenFed Credit Union, one of the largest credit unions in the nation. Of course, every lender has its own credit criteria to approve new loans.

Unsecured personal loans can range from several hundred dollars to thousands of dollars for borrowers with good credit. In the first quarter of 2023, the average lump sum of an unsecured personal loan was $7,100, according to TransUnion.

A personal installment loan can finance just about anything — medical bills, home improvements, or to pay off higher interest rate credit cards (called a debt consolidation loan). However, some lenders prohibit the funding of a business, college tuition or particular investments. Ask your lender about any restrictions when doing your research.

Some lenders will consider borrowers with less-than-perfect credit or with limited credit histories. However, it may take getting a cosigner to help guarantee the loan. That's someone who will agree to make the loan payments in the event that you can't.

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