You may have heard the term ‘unsecured loan’ thrown around before, but do you really know what it means? We’ll outline the definition of an unsecured loan, how it works, types of unsecured loans, and how it differs from a secured loan in this post. The more you know about an unsecured loan, the better you can gauge whether it’s the right fit for your situation and credit score.
What is an unsecured loan?
Let’s jump right into it! An unsecured loan is a loan that is issued and supported on the borrower’s creditworthiness alone–no collateral required (aka ‘no collateral loans’). Unsecured loans can go by other names, like signature loans or personal loans. The nice thing about an unsecured loan is that you don’t have to worry about losing your home or car should you default on your loan.
Because no collateral is required, lenders rely on your credit score to indicate how likely you are to pay the loan back. Certain unsecured loans require high credit scores (600s and 700s) for a borrower to be approved. The higher your credit score, the lower your interest rate will be.
Types of unsecured loans
Unsecured loans can come in many forms depending on what they’re being used for and whether the monthly payment amount is fixed or flexible. Student loans, personal loans, and credit cards are all types of unsecured loans.
A signature loan requires nothing but your signature to get the ball rolling. With your signature, you are making a promise to pay back your debt. Signature loan lenders are typically banks or credit unions, and your loan can be used for anything. The lump-sum they provide is paid back in installments over time, with fixed monthly payments that do not fluctuate. If you’re looking to build credit with low-risk, signature loans are a great choice.
Personal line of credit
Another type of unsecured loan is a personal line of credit. Unlike a personal loan, a line of credit is not given in a lump sum. Instead, you are approved for a specific amount that you can use and payback as needed. As the balance is paid down through your repayments, your line of credit becomes available again for you to draw from. Keep in mind that interest is only paid on the part of the credit line that you’ve borrowed.
Many people use credit cards to not only borrow money but to build up their credit score. For those who pay off their credit card debt at the end of the month, it acts almost like a debit card. Though you don’t receive a lump sum of money, you borrow what you need when you need it (up to your credit limit). Credit cards are a quick way to access cash if you can handle the high-interest rates and are responsible enough to pay them off in a timely manner.
Peer to peer loan
A peer to peer loan is one of the newer forms of unsecured loan options and operates solely via the internet. Essentially, a peer to peer loan allows you to borrow from an individual rather than a bank or credit union. Through these websites, you can post a request and see whether someone offers to fund your loan. While interest rates are competitive and the borrow cap can be high, you may have more issues getting a peer to peer loan if you have a low credit score.
The unsecured loan that you might be most familiar with is student loans. Unlike the types mentioned previously, this loan can only be used toward educational funding. Because they’re geared toward students though, there are certain perks that come with them (including flexible repayment options, grace periods, interest subsidies. etc.). You can only qualify for these loans if you are a student, and they must be attained through the financial aid office at your college or university.
How do unsecured loans work?
Now that we’ve established what an unsecured loan is and different types of unsecured loans, let’s dive into how they work.
The approval process is quick with unsecured loans online, but the requirements for approval are more intense than with a secured loan. Credit score, income, and other factors will help determine whether a lender approves or denies your application. In the case that you’re denied due to insufficient credit, you can try re-applying with a cosigner who will take on your debt obligations should you default.
Once approved, you and the lender will establish terms of repayment (interest rate, loan lifespan, etc.) and set up a schedule for when your payments will be made. Oftentimes, a lender can be flexible with this depending on when you get your paycheck.
Defaulting on an unsecured loan
Should the worst happen and you default on your loan, you don’t have to worry about your home or car being taken away as you might with a secured loan. Instead, your credit will be affected and lenders will put your account into collections. From there, the lender will be forced to take legal action (possibly in the form of a lawsuit) in order to recoup the debt. This may result in the lender garnishing the borrower’s wages or a lien being placed on the borrower’s home.
It’s best to think about the long term effects of defaulting. Collections and civil judgments take seven years to be removed from your credit report. Should your credit score be affected negatively, you may not qualify for future loans. Or if you do qualify, you may have a higher interest rate than in the past. Make sure you’ll be able to make your payments before taking out an unsecured loan.
What is the difference between a secured and unsecured loan?
A loan can be either secured or unsecured. A secured loan differs from an unsecured loan in that the borrower provides some type of collateral in the form of a home, car, etc (something that has more or equal monetary value to your loan amount). This collateral is used to provide security for the lender–they know you have an incentive to pay the loan back, and they have an asset they can sell to recoup their losses should the borrower default. Because there’s collateral, lenders often offer lower interest rates.
The great thing about secured loans is that if you’re making payments on time, you’ll never have to worry about your collateral being seized. You’ll also be building up your credit along the way! With a secured loan, the borrower can normally take out larger sums with better terms–even if they have a lower credit score.
Types of secured loans
More likely than not, you already have a secured loan. The more common secured loans are mortgages, auto loans, and home equity lines of credit (HELOCs). Should you default on your mortgage, your home would be seized by the lender.
Apply for an unsecured loan
If you’d like to get an unsecured online bank loan, take a few minutes and fill out a personal loan application with Helix and get an answer within minutes. Take a look at our options and make a choice on a lender that is right for you. Keep in mind our personal unsecured loans are paid in weekly, bi-weekly, or monthly installments, so you can make smart budgeting decisions.