Unsecured personal loans are increasingly appealing to Americans straddled with debt and high living expenses.
Roughly 14 million U.S. consumers currently use the loans. On average, their debt balances have increased from $5,907 at the end of 2011 to $7,599 in 2016, according to credit monitoring firm TransUnion.
Millennials are especially trapped. Young professionals establishing a long-term career or preparing for graduate school are 1.2 times more likely than other demographics to carry a personal loan.
Here’s a guide to unsecured personal loans and the best way to get one.
What are unsecured personal loans?
“Personal loans are often ad-hoc sources of funds meant to cover large, everyday expenses in lieu of credit cards,” according to a PricewaterhouseCoopers report.
The debt isn’t backed by the borrower’s property or assets, giving lenders less protection from default. These loans are often known as signature loans because creditors are essentially basing their expectations for repayment on the debtor’s word (credit cards work the same way).
Most personal loans are unsecured and can be taken out for any number of uses, including home improvements, travel, weddings and business expenses and debt consolidation. Lenders include banks, credit unions and online organizations.
They generally hand out unsecured personal loans as a lump sum, which is then paid off in regular installments. Terms are relatively short — just a few years.
Secured vs. unsecured personal loans
Secured loans requires borrowers to offer up physical property — such as a home or vehicle — or other assets as a lien against the debt. Lenders can seize the collateral to recoup their losses from a default, which makes loans loans riskier for debtors, who have something definitive to lose if the loan isn’t repaid.
With the upper hand, lenders tend to be more generous with secured loans, offering longer payback periods, higher loan limits and lower credit rates. They’re also more accepting of borrowers with weaker credit scores. Go here for a deeper dive into secured personal loans.
Borrowers with unsecured loans only promise to repay the debt, without producing proof that they’re able to. These loans are more dangerous for creditors, who don’t have much of a guarantee of being made whole. They can’t automatically claim the borrower’s property. Instead, they must turn to a collections agency or drag the borrower to court. And only if the lender wins the case will it be allowed to garnish the borrower’s wages or otherwise compel payment.
Those seeking unsecured personal loans face more hurdles to compensate for the lender’s risk and potential hassle. But unsecured personal loans are more common, and the lack of collateral means there’s usually less paperwork, resulting in faster approvals.
What’s the best way to apply for an unsecured personal loan?
For more personalized service, head to a bank. You’ll face fewer fees associated with loan origination, check processing or prepayment. But some institutions will require you to be an existing customer.
Often, though, online lenders will have more transparent lending standards and a streamlined application processes. Their loan limits and payment timetables may be more flexible.
For borrowers shopping around for the best loan options, check out SuperMoney’s personal loan reviews here.
Where are the lowest rates?
Broadly speaking, the better your credit score, the lower your interest rate.
Banks will generally have a smaller range of APRs. At Wells Fargo, those with fair FICO credit of 621 to 699 can expect an average 15% APR. Good credit of 700 to 759 leads to an average 10% APR. Excellent credit is linked to an average 5% APR.
Peer-to-peer lenders such as LendingClub have higher tolerance for lower credit scores, but those APRs won’t be low, ranging from 5.99% for spectacular credit and a 36-month term to 35.89% for a less-than-impressive score.
Average-credit borrowers must usually settle for higher APRs and also longer wait times for funds delivery, shorter payback terms and smaller loan amounts from lenders, such as Peerform or Avant. Vouch puts a spin on co-signing — instead of saddling a single guarantor with the risk carried by the entire balance, the debt is broken up into chunks.
Sometimes, though, credit isn’t the only qualification for a single-digit rate. LightStream, an extension of SunTrust Bank, looks for income stability and savings history. Earnest targets younger borrowers with skimpy credit history but a good education and career trajectory. SoFi checks the debt-to-income ratio and employment track records.
The Federal Deposit Insurance Corporation recommends that small-dollar loans of $2,500 or less be capped at a 36% APR to be considered affordable. Any higher, and repayment becomes unlikely, according to the National Consumer Law Center.
What to know before applying
Be wary of lenders who dangle an unsecured personal loan without requiring a credit check. Often, these are payday lenders or scammers. Their APRs frequently stretch into the triple digits. Protect yourself by looking up lenders with your local state regulator or the Better Business Bureau.
Shop around for different options. Many online lenders will let you request proposals without conducting a hard pull of your credit history and dinging your score.
Ensure that the lender will report your loan activity to the credit bureaus — disciplined repayment will help you build credit. Plan out your repayment schedule. Loans with longer terms will be more expensive due to interest, but payments will be more manageable. Shorter terms equate to higher payments but less interest buildup.
Think hard about why you want an unsecured personal loan in the first place. If your credit is great and you can think you can pay off the debt in less than 18 months, you might qualify for a more economical credit card with a low or zero introductory APR.
Want to take the next steps with a loan? Check out these personal loan reviews.