If you need to borrow money for a significant purchase, you may be considering an unsecured personal loan. But what are they exactly? And how do they work?
From familiar types of unsecured loans to how to qualify for one, this helpful primer will break down what you should know to make an informed decision about this common form of borrowing.
What is an unsecured loan?
Unsecured loans are loans that do not require collateral, something of value that you own – such as a vehicles, home or a boat – that guarantees your loan in the event you default on your payments.
It’s important not to confuse unsecured loans with secured loans, which do require collateral. (If you’d like to know more about this topic, this article on the difference between secured and unsecured loans can help.)
Unsecured loans can be a reasonable choice to consider if you have credit that falls within the “good” credit score range.1 They’re also an option if you don’t want to back your loan with a valuable asset (and risk losing it, should you default on your payments).
Your credit score will not only determine the kind of loan you’re approved for, but how much you can borrow. People are often presented with a choice between unsecured and secured loan options. While unsecured loans typically offer a lower amount of money, you may find that a smaller, unsecured loan – without the need for collateral – may wind up meeting your needs.
Types of unsecured loans
You may already be familiar with unsecured loans without even realizing it. Here’s a sampling of some common unsecured loans:
Car loans Used to purchase a new or used vehicle, car loans – a type of installment loan – are dispersed as a lump sum to pay dealerships or private sellers. Borrowers repay these unsecured loans over a set period of time via monthly payments.
Personal loans These types of unsecured loans, also an installment loan, can be used for any reason. Debt consolidation is a common use for unsecured personal loans, as are emergency expenses and medical bills.
Student loans Used to pay for college or graduate school tuition, room and board, books and other supplies, student loans are unsecured loans issued either by the government or private lenders. Monthly payments typically start after a six-month postgraduation grace period.
Credit cards While they may not seem like loans at all, credit cards are also a type of unsecured loan. Distinctly different than personal loans, credit cards allow borrowers to make purchases and pay the lender back later.
Personal line of credit Like credit cards, personal lines of credit are based on revolving credit. This means that minimum monthly payments will change based on a borrower’s interest rate and how they spend.
Unsecured loan approval process
Since they require higher credit scores, qualifying for an unsecured loan can be challenging if you have less-than-perfect credit.2 If you fall into this category, take time to talk to loan specialists about different options that could work with your credit history. There’s also a number of things you can do to improve your chance of getting approved for an unsecured loan.
Start by checking your credit report. If you find any errors, contact creditors immediately to investigate each discrepancy. You can also lower your debt-to-income ratio or ask a family member or close friend to cosign on your loan. Another good idea is to check your eligibility before you apply, something called prequalification. This can help you avoid a hard credit inquiry, which, when done repeatedly, can negatively impact your credit.
Do your research (and take your time)
An informed borrower is an empowered borrower, so take the necessary time to thoroughly research your unsecured loan options. If you need to improve your credit, take time to do that, too. Applying for the right type of loan, when you’re ready, increases your chances of being approved.
1 Akin, Jim. “What Credit Score Is Needed for a Personal Loan?” Experian.com. https://www.experian.com/blogs/ask-experian/what-credit-score-is-needed-for-a-personal-loan/ (accessed July 13, 2020).
2 Experian. “Secured vs. Unsecured Loans: What You Should Know.” Experian.com. https://www.experian.com/blogs/ask-experian/secured-vs-unsecured-loans-what-you-should-know (accessed July 13, 2020)