BLUEPRINT

Advertiser Disclosure

Editorial Note: Blueprint may earn a commission from affiliate partner links featured here on our site. This commission does not influence our editors' opinions or evaluations. Please view our full advertiser disclosure policy.

Key points

  • Provided by banks, credit unions and online lenders, an unsecured loan is a type of loan that doesn’t require any collateral.
  • If you fall behind on payments on an unsecured loan, you don’t have to worry about losing your home, car or other asset.
  • However, to get an unsecured loan, you need to meet a lender’s underwriting requirements for credit and income, which can be loftier than the ones you’d need to meet for a collateral-backed loan.

An unsecured loan is a debt product that doesn’t require any collateral, such as a house or car, for approval. Instead, a lender relies on your credit, income and other financial credentials to determine whether you qualify for the loan.

“An unsecured loan is only backed by the credit score and paying ability of the borrower,” says Mahesh Odhrani, a Certified Financial Planner and president of Strategic Wealth Design. “The lender does not have any collateral to take to recover its losses if the borrower does not pay the loan.”

Some common types of unsecured loans are personal loans and student loans. Unsecured personal loans often go by other names, such as debt consolidation loans or home renovation loans, but they all essentially work the same.

How do unsecured loans work?

You’ll need to meet a lender’s underwriting requirements to qualify and can use the funds for almost anything you want. Borrowers with the strongest credit tend to get the most competitive rates, while borrowers with weaker credit face higher rates and potentially lower loan limits.

If you can’t meet loan requirements on your own, some lenders let you apply with a cosigner. Adding a creditworthy cosigner to your application can help you qualify or get better rates. However, your cosigner will be equally responsible for the debt and will be liable for repayment if you can’t pay it back. (You could also apply for a joint loan with a co-borrower who would have equal access to the loan funds — and legal responsibility for repaying it.)

Unsecured loans are often installment loans that you pay off over time, according to a repayment term you agree to at signing.

How unsecured personal loans work

After approval, you receive a lump sum upfront that you can spend pretty much however you like. Some common uses of personal loans include home renovations, debt consolidation, medical bills and wedding expenses, but the list goes on.

After receiving the loan, you make monthly payments for a set period of time, typically two to seven years. Most unsecured personal loans range from $2,000 to $50,000, though some lenders offer up to $100,000. Fixed interest rates typically start around 6% and can go up to 36% (though there may also be origination fees).

When you apply for an unsecured personal loan, lenders will look at your credit, income, debt-to-income ratio and other factors. Your credit history gives the lender insight into how you’ve handled debt in the past. Since a lender sees someone with a positive credit history as less risky, it will offer better rates and terms to that applicant than to someone with a negative or thin credit history.

Unsecured loan example

Let’s say that you want to borrow a personal loan to pay for home renovations. You kick off the process by checking your rates with a few different lenders. Many online personal loan companies let you check your rates with no impact on your credit score. If you see an offer you like, you can move forward and submit a full application.

For the sake of our example, let’s say you qualify for a $20,000 unsecured personal loan at an 11% interest rate and choose a repayment term of five years. Assuming no other fees, you’ll pay your loan off in full after making 60 monthly payments of $435. Over the life of your loan, you’ll pay back the full $20,000 plus $6,091 in interest charges.

If you opt for a shorter repayment term, your monthly payment will be higher but you’ll pay less in interest charges. Conversely, choosing a longer term will give you more affordable monthly loan payments, but you’ll be in debt longer and consequently pay more interest over the life of your loan. Toy with the numbers using a loan payment calculator like Calculator.net’s.

Pros and cons of unsecured loans

PROSCONS
You don’t have to pledge any collateral to borrow the loan
You may see higher interest rates and lower loan amounts than you would on a secured loan
The application process and funding time may be faster than they would be to borrow a secured loan
Unsecured loans can be difficult to get approved for if you have bad credit (or you could get stuck with a high interest rate)
You’re not at risk of losing your assets if you fall behind on payments
Defaulting on an unsecured loan could damage your credit—your debt could also get sold to a collections agency, and a lender could bring you to court
Good-credit borrowers could qualify for competitive interest rates
Unsecured personal loans can be used for almost any purpose

Unsecured vs. secured loans: What’s the difference?

Unsecured loans, which don’t require collateral, stand in contrast to secured loans, which do. Some common examples of secured loans are home loans and vehicle loans, which are backed by your home and car, respectively.

Because unsecured loans don’t require collateral, they may be faster to obtain than secured loans.

“Unsecured loans are simpler to process and qualify for as the banks are using the individual’s credit score and income to qualify them,” says Odhrani. “The approval process is generally much quicker.”

Secured loans, however, may come with lower interest rates and higher borrowing amounts than unsecured loans. Credit and income requirements may also be more relaxed, since a lender relies more heavily on the value of your asset than your credit score during the qualification process.

If you default on a secured loan, though, a lender could seize the asset that you pledged as collateral. Homeowners who default on their mortgages could see their home go into foreclosure, for instance, while borrowers who fall behind on their vehicle loans could lose their car.

On the other hand, a lender can’t seize your home, car or other assets if you default on an unsecured loan. They could decide to bring you to court, but they can’t directly take any of your belongings, since you didn’t back up the loan with collateral.

Missing payments on any type of loan, whether unsecured or secured, can severely damage your credit. Late payments and other red marks usually stay on your credit for seven years, making it difficult to qualify for other loan products in the future.

Frequently asked questions (FAQs)

Most lenders look at your credit history and debt-to-income ratio when deciding whether or not to approve your application for an unsecured personal loan. Requirements vary by lender, but most like to see a credit score that’s fair or better. On the FICO scoring model, a fair score starts at 580 and a good score starts at 670.

You can apply for an unsecured loan online or in-person at a bank or credit union. Many online lenders let you prequalify for an unsecured loan with no impact on your credit score, allowing you to shop around and compare offers. When you submit a full application, a lender will run a hard credit inquiry, which will ding your score by a few points. As part of your application, you may need to upload documentation, such as pay stubs or bank account statements. Some lenders can process applications and distribute funds in just one business day.

Because an unsecured personal loan is not secured by collateral, a lender can’t seize your belongings if you default. However, it will report your missed payments to the credit bureaus, resulting in damage to your credit score. Your debt could get sold to collections agencies, which could call you (and any cosigner) demanding repayment. A lender might also decide to sue you in an attempt to get the debt repaid.

Blueprint is an independent publisher and comparison service, not an investment advisor. The information provided is for educational purposes only and we encourage you to seek personalized advice from qualified professionals regarding specific financial decisions. Past performance is not indicative of future results.

Blueprint has an advertiser disclosure policy. The opinions, analyses, reviews or recommendations expressed in this article are those of the Blueprint editorial staff alone. Blueprint adheres to strict editorial integrity standards. The information is accurate as of the publish date, but always check the provider’s website for the most current information.

Ben Luthi

BLUEPRINT

Ben Luthi is a freelance writer who covers all things personal finance and travel. His work has appeared in dozens of online publications. Ben lives in Salt Lake City with his two children and two cats.