Lenders make signature loans to borrowers who cannot or do not wish to put up collateral to qualify for secured loans. These products are also referred to as personal loans, unsecured loans or character loans. Lenders have only the promise of the borrower that the money will be repaid as agreed, so this kind of financing is largely reserved for those who have compiled a good credit history and a track record of managing debt effectively.
Lenders approve signature loans based on the applicant's credit score (which denotes the willingness to pay), income (which indicates the ability to repay) and debt-to-asset ratio. To offset risk, lenders charge higher interest rates than they do for secured loans. You can check your credit score for free at Lending Tree.
Signature loans in 2014 were made at approximately five- to six-percent for borrowers with top-drawer credit qualifications. Persons with poor credit can also qualify for high-risk signature loans, but they may pay upwards of 30 percent to balance the lender's risk, and the loan amounts may be considerably smaller. For these applicants, a co-signer may help lower some of the costs. (Caution: products advertised as "signature loans with no credit check" or "personal loans with no credit check" or "unsecured loans with no credit check" are actually title loans, payday loans or cash advances, featuring extremely high fees and interest rates well over 100 percent. Stay away from those.)
Benefits and Uses of Signature Loans
Unsecured loans can be used for any purpose and are well-suited to cover unexpected financial challenges, for example, family emergencies. Some consumers take out a signature loan to help pay medical bills, buy big-ticket items for their homes or launch a business. For some, a personal loan is the only way to round up cash needed for investments, relocation, or buying a vehicle or consolidating high-interest debt. Here are their main advantages:
- Assets don't need to be put up as collateral
- The rates are usually better than those of credit cards
- Terms range between one and five years and rates are usually fixed. That makes budgeting easier.
- Adding them to a mix of credit and making payments as agreed can increase credit score.
- Delivers a lump sum of cash without the "cash advance" fee charged by credit cards.
How advantageous a signature loan is depends on the terms. For the best terms, consumers should shop and compare products from several competing lenders.
Unsecured Loan Drawbacks
One drawback is the misconception that the borrower can walk away from the loan without repercussions. Unsecured loans are safer for borrowers than secured loans, because there is no collateral for lenders to repossess. That does not, however, mean borrowers can default any time they don't feel like repaying the creditor.
Once your signature loan has been written off by your lender, your account will likely be transferred to a collection agency. Ig your balance is high enough to make it worth the effort, a collection attorney may take you to court and obtain a judgment against you. You'll be ordered to pay the debt plus legal fees – and it becomes a public record. Even worse, your assets are no longer protected -- a judgment allows a lien on your house or garnishment of your wages.
Unsecured loans come with higher interest rates than secured loans because they are riskier to the lender. However, the higher costs can be mitigated somewhat by borrowers shopping carefully to get the best deal available.