There may be times when you need to cover unexpected expenses or pay for major purchases. An unsecured personal loan can help you fill the void in your budget where you can borrow the amount of money you need and pay it back in installments.
No collateral is required as approval is based on the borrower’s creditworthiness and ability to pay back the loan.
What is the difference between a secured and unsecured personal loan?
A secured loan requires the borrower to provide collateral that can be used to repay the loan in the event of default. The loan application is based less on the creditworthiness of the borrower and more on the value of the borrower’s assets.
An unsecured loan is based on the borrower’s credit profile and doesn’t require you to back your loan with an asset. If you miss payments or default on your loan, it could negatively impact your credit score, and your ability to access other types of credit at favorable interest rates.
What can I use an unsecured personal loan to finance?
When considering taking out a personal loan for discretionary purposes, it’s a good idea to compare different financing options as there may be cheaper alternatives.
How does an unsecured personal loan work?
In most cases, you can borrow between $1000 and $100,000 for an unsecured personal loan. Lenders will require monthly repayments of the principal loan amount plus interest.
When you apply, the lender will perform a hard credit check. Depending on your credit history, with an excellent credit score, you could receive an interest rate as low as 6%. Borrowers with bad or no credit history could pay as much as 36%.
Other factors that can impact the outcome of your loan application include your income, debt-to-income ratio, and if you have a cosigner.
Your repayments will be reported to the major credit bureaus. If you pay your loan back on time, you could be rewarded with a better credit score that could help you get approved for future credit applications. If you fail to pay back your loan or miss a payment, this could harm your creditworthiness.
Benefits of unsecured personal loans
There are many benefits to taking out an unsecured personal loan, including helping you cover a financial shortfall during a time of need.
Some of these benefits include:
- No risk to personal assets: If you default on your loan, the lender cannot take your personal assets as compensation. If you fall into economic hardship, you won’t have to worry about potentially losing your house.
- Easy application process: As there are no assets to value, the application process can require less documentation. Some online lenders will approve your loan in as little as 2 to 5 business days.
- A great option for smaller amounts: If you need to borrow a smaller amount, an unsecured personal loan could be a great option as it requires less documentation and has a faster turnaround.
Disadvantages of unsecured personal loans
While there can be many advantages to taking out an unsecured personal loan, it’s important to consider the drawbacks that could impact your finances.
The main disadvantages include:
- Higher interest rates: As there is a greater risk for the lender, this is factored into the cost of borrowing and lenders will charge higher interest rates.
- Smaller loan amount: Typically, lenders will lend smaller amounts as they do not have collateral to cover their risk.
- Default and liability: If you miss a payment or default, legal action could be taken against you or your loan could get passed onto debt collectors.
How to qualify for an unsecured personal loan
Criteria to qualify for a personal loan can vary between lenders. But there are a few key factors a lender will review in your loan application:
- Good credit: Your credit history is an indicator of how risky you are as a borrower from the perspective of a lender. The majority of lenders require a minimum of good credit, where borrowers with excellent credit will have access to the lowest interest rates.
- Debt-to-income ratio: Many lenders require a debt-to-income ratio of 36% or less, and other lenders may be more stringent. If your ratio is high, it can indicate to lenders that you already have a high burden of debt and you may be in financial distress applying for another loan.
- Income: Lenders will review your income sources as this will provide evidence of your ability to repay the loan.
- Cosigners: If you have a cosigner for your loan with a high credit score, it can improve your chances of approval and also lower your rates.
Tips for choosing the best unsecured personal loan
When shopping around for an unsecured personal loan, you’ll want to compare multiple lenders and choose a loan with terms and conditions that best meet your financial needs. Here are some tips to keep in mind:
- Fees: There are many fees to look out for on a personal loan. Some of these fees include origination fees, early repayment penalties, and late fees. The origination fee can be 1 – 6 % of the loan amount. It’s important to consider this when calculating your loan amount as you could fall short of what you need.
- Interest rate: Personal loans typically come with a fixed interest rate. It’s a good idea to compare multiple lenders because high-interest rates could end up costing you thousands of dollars in extra payments.
- Be aware of restrictions: Some lenders may have specific purposes for which you can use the borrowed amount. For instance, some lenders will not lend money for a personal loan if it is used to buy a car. If you fall outside of these restrictions, it’s best to look for a lender that can help you with your intended purpose for the money.
- Credit score: If you know in advance that you’ll be applying for a personal loan, you have the opportunity to build a better credit score that could help you secure more favorable rates. Be mindful to pay your bills on time and lower your debt-to-income ratio if needed.
- Stay guarded against unfavorable deals: If you have bad credit you may have more difficulty in finding a reputable lender. Be aware of predatory lenders that could approve a loan with very high-interest rates, making it more difficult for you to get out of debt.
- Loan term: A longer loan term can have lower repayments every month but you’re likely to pay more back in interest throughout the loan. Keep in mind what you can afford to pay when choosing your repayment term.
How do you apply for an unsecured personal loan?
If an unsecured personal loan is right for you, you can apply in a few simple steps:
- Compare multiple lenders: Shop around and compare interest rates, fees, and repayment terms with multiple lenders to find the best loan for your financial needs. Many banks, credit unions, and online lenders offer unsecured personal loans. It could be a good idea to visit your local bank or credit union that you have a relationship with, as this may help secure more favorable terms.
- Prequalify for a loan: Take into consideration multiple offers from lenders. Prequalification does not guarantee that your loan application will be accepted, but it can be an indication of the rates and terms you are likely to receive.
- Choose a lender and submit your application: After choosing the lender you can submit your loan application and provide the required documentation to support your application. Some documents can include proof of address, personal ID, and proof of income.
- Approval and payment of funds: If you are approved, you can expect to receive the funds within the number of business days specified by the lender.
Can I get an unsecured personal loan with bad credit?
Borrowers with bad credit are likely to qualify for loans with higher interest rates. In addition, you may need a cosigner to apply for a loan.
A cosigner adds a second borrower to your loan agreement essentially acting as a guarantor if the primary borrower defaults. For borrowers with bad credit, this increases the chances of approval as the lender has greater confidence that they will be repaid.
Here are a couple of tips to keep in mind if you have bad credit and you’re looking for an unsecured personal loan:
- Maximum interest rate: When comparing loans, you’ll want to compare interest rates at the top range of the loan, as this is where you’re most likely to land.
- Additional fees, penalties, and charges: If you lack confidence in your ability to make repayments on time, look out for penalties related to late payments. Not only can your credit score be negatively impacted, but the extra fees can become a financial burden and increase the total amount you have to pay for the loan.