An unsecured loan is a loan that is not secured by collateral, such as a car, a home, or savings in a bank account.
They are also known as consumer loans, installment loans or signature loans. Unlike mortgages and most auto loans, unsecured loans don’t require you to provide a valuable asset as a security. They are also different than credit cards, which offer an open line of credit. You get a lump sum of money and you pay it back in a set number of installments.
Who should consider an unsecured personal loan?
If you need money and you don’t want the risk of placing a valuable asset as collateral, you may want to consider an unsecured loan. Personal loans can be funded in 48 hours or less and you can use them for almost anything you want. You will need good credit to qualify for low rates and fees, but even borrowers with poor credit can qualify for a loan.
Pros and Cons of unsecured personal loans
Here is a list of the benefits and the drawbacks to consider.
- Fast access to money
- No need for collateral
- Manage your budget with fixed monthly payments (mostly)
- Can be discharged with a Chapter 7 bankruptcy
- Best rates require a good credit score
- Higher rates than secured loans
Unsecured personal loans – A brief history
Although borrowing is as old as mankind, large-scale lending operations have focused primarily on secured loans for most of history. Secured personal loans were usually based on property, such as mortgages, vehicles, family heirlooms (pawn loans), or next season’s harvest.
The reason is obvious. Few lenders want to risk being left with a handful of worthless loan contracts. Asking for collateral made lending a viable business. Unsecured loans were mainly left to fringe and underworld lenders who had other methods to secure their investment.
After World War II, new forms of credit, such as payday loans, credit cards, overdraft protection, bank lines of credit, and unsecured personal loans, became more popular.
Unsecured personal loans, credit scores, and statistics
Changes in technology and financial theory have accelerated the growth of unsecured personal loans. Lenders now have access to mountains of publicly available financial data and the credit scoring tools and software required to analyze them. The advent of centralized credit bureaus and credit scoring models are a driving force for unsecured lending.
Now, lenders can make decisions based on hard data instead of relying entirely on human judgment. This makes underwriting unsecured personal loans faster, cheaper, and financially viable. As of 2017, only 0.74% of personal loans are delinquent (90 to 180 days past due). Not bad when you compare unsecured personal loans to mortgages, which had a delinquency rate of 3.49% (source).
How to compare unsecured personal loans
The key features to look at when shopping for a secured loan are the APR, the origination fee, and the length of the loan’s term.
Annual percentage rates
The APR of a loan represents the cost of borrowing. To compare personal loan providers, check their annual percentage rates (APRs). It represents the total interest rate of a loan over a one year period.
APRs vary depending upon your credit score. The table below gives you an idea of the rates you can expect based on your credit score.
The lower the APR, the less the personal loan will cost you. Usually, this is the most important factor when you compare personal loans.
Origination fees are charged by lenders to cover the cost of setting up and processing an unsecured loan. They are expressed as a percentage of the loan amount and vary depending on your creditworthiness and the loan’s term. Fees can vary from 1% to 6% of the loan amount. For example, if you borrow $10,000 and the origination fee is 5%, you will pay $500. This fee is deducted from the loan amount. In the example above you would only receive $9,500.
Yes, that’s right. Most lenders that charge an origination fee deduct the amount from the loan. You receive less than the total value of the loan. The good news is that many lenders, such as SoFi, Earnest, and Barclays, don’t charge an origination fee.
The term length of a loan often determines whether borrowers can afford the monthly payments. Unsecured personal loan terms generally range from 12 to 60 months. To illustrate, a $10,000 loan with a 10% APR and a 3-year term will have monthly payments of $323. The same loan with a 12-month term will have monthly payments of $879. The shorter term is much more affordable, but it will cost you $1,066 more in interest over the life of the loan.
Find the best unsecured loans
The problem when shopping for a loan is that not all lenders are transparent about their fees and rates. Even savvy borrowers may not always get the best deal available. It’s difficult to know what rates you qualify for without applying with every major lender. And if you do, your credit will probably take a hit.
SuperMoney makes it easy to compare lenders and loans by setting their key features side by side. Our personal loan offer engine allows you to receive prequalified offers from leading lenders without hurting your credit.