What Is an Unsecured Loan?

Written by Kim PinnelliReviewed by Anders Skagerberg, CFP®Updated: 15th Apr 2022
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You don’t always have to put down collateral to borrow money. If you only need a small amount and have good credit, you may benefit from an unsecured loan. These personal loans are easy to get and have their time and place where they are beneficial.

Here’s what you need to know about unsecured loans, how they work, and whether or not it is a loan worth considering.

What Is an Unsecured Loan?

Unsecured loans, as the name suggests, are loans without collateral. When you put down collateral, such as a house or car, the lender can repossess the item if you don’t make your payments. With an unsecured loan, there isn’t anything to repossess.

Unsecured loans pose a higher risk for lenders because there aren’t any assets to fall back on, but they aren’t impossible to get.

>> More: See the Best Personal Loan Rates

How Do Unsecured Loans Work?

You can get unsecured loans from your local bank, a credit union, or an online lender. They typically offer lower loan amounts than secured loans because of the risk. Most lenders allow unsecured loans starting at $1,000 and up to $50,000 – $100,000 depending on the lender.

You receive the funds at one time and make monthly payments (principal and interest) for the term. The terms are usually short – around 2 – 5 years, but the interest rates are higher than you’d get with a secured loan because lenders need to make up for the risk.

Pros and Cons of Unsecured Loans

Unsecured loans have their ups and downs. Understanding the good and bad can help you decide if they are right for you.

Pros:

  • Unsecured loans fund fast. Since there isn’t any collateral to evaluate, lenders can underwrite your personal financial situation, quickly getting you funds in as few days.
  • You don’t have to worry about losing any collateral if you can’t make your payments.
  • Unsecured loans are usually fairly easy to qualify for as long as you have good credit.

Cons:

  • Most lenders require great credit to qualify for an unsecured loan.
  • If you don’t have great credit, you may find it harder to qualify.
  • You might pay high-interest rates to make up for the risk of no collateral.

How to Qualify for an Unsecured Personal Loan

The good news is that qualifying for an unsecured personal loan is easy – much easier than applying for a home equity line of creditor home equity loan. Here’s what you must know.

Credit Score Requirements

You don’t need perfect credit, but the higher your credit score is, the better the terms you’ll get. A 700+ credit score is desired, but you can likely still get approved with a lower credit score but expect a higher interest rate.

Income

You don’t need to make a certain amount of money to qualify, but you must make enough to cover your current debts, plus the new loan. Lenders look for a stable income that you have a history of earning for the last two years, which will continue for the foreseeable future.

Debt-to-Income Ratio

Lenders use your debt-to-income ratio to decide if you qualify for a loan. Your DTI compares your monthly debts (including the new loan) to your gross monthly income or your income before you pay taxes.

Ideally, it would help if you had a DTI of 40% or less to get the best rate and terms on an unsecured loan.

Assets

Some lenders may look at your bank accounts. They aren’t looking for a certain amount of assets but rather how you handle your assets. Does your checking or savings account ever have a negative balance? Do you transfer funds a lot? They look at your activity to get an idea of your financial situation.

How to Apply for an Unsecured Loan (Step-by-Step)

#1. Review Your Credit Score

Your credit score is the first thing lenders look at to decide if you’re a good candidate for the loan. Before you apply, pull your credit and make sure it’s in good standing. You can get access to your credit score from most banks or credit card companies and ask if free credit score monitoring is a part of your benefits.

If not, pull your free credit report here(no score) and make sure you don’t have any negative information on it, such as late payments, credit cards with over 30% of the credit line outstanding, collections, or any incorrect information.

#2. Calculate How Much You Need to Borrow

Know how much you need. Why are you borrowing the money? Is it to pay for an emergency that already occurred? Are you fixing up your house? Think about how much you need and only borrow that amount.

#3. Compare Lenders and Rates

Try to get quotes from at least three lenders. This will help you see what rates and terms different lenders offer. One lender might find your credit score too low, while another allows that score. You can choose the loan that has the best rate and terms. Don’t get stuck on the interest rate, but instead, look at the overall cost of the loan. How much is the bottom line? You want the loan that costs the least in the end.

#4. Prequalify Online

After evaluating your options, get your prequalification online. It takes only a few minutes to complete each application, and it doesn’t hurt your credit score. They do a soft inquiry to give you a rate. You can then compare your options and move forward with the lender that makes the most sense for you.

#5. Apply Online

Once you’ve chosen your lender, apply with the lender online. This is when they will do a hard inquiry in your credit report, so make sure you choose the lender you’re comfortable using so you only get one inquiry on your credit report.

The lender will ask for specific documents to underwrite your loan and complete the process, usually in a day or two.

#6. Receive Funding

You’ll receive funding shortly after getting the loan approval. Lenders typically wire the funds directly to your bank account.

#7. Make Monthly Payments

The following month after you receive your funds, your payments will start. You’ll owe principal and interest on the same day each month. The amount you owe won’t change, and as you pay your balance down, you’ll pay more toward your principal than interest.

>> More: How to Apply for a Personal Loan

Where Can You Get Unsecured Loans?

Traditional Banks

Traditional banks offer unsecured loans in-person and online. They usually have the toughest requirements, though, so make sure you include other lenders in your search. If you have a banking relationship with a traditional bank, you may get better rates and terms, but it’s always worth checking.

Credit Unions

Credit unions offer some of the best rates and terms on unsecured loans. Because they are not-for-profit, they charge fewer fees and lower interest rates. Credit unions often have more flexible underwriting guidelines too.

You must belong to a credit union to use one, though. Check with your employer or any organizations you belong to and see if you can join a credit union because of your affiliation.

Online Lenders

Online lenders offer the most flexibility and options. You’ll find lenders that operate only online as well as peer-to-peer lenders that cater to borrowers with less than perfect credit. Do your research and make sure the lender is legit before sharing your information but include online lenders in your search. Since their overhead is less than a traditional bank, you can often get better rates and terms.

Are Unsecured Loans Bad?

Unsecured loans are a great way to get your hands on a small loan for something you need immediately. While the interest rates might be higher than a secured loan if you’re borrowing for the short term and only a small amount, it’s not a bad way to get the funds you need fast.

Is It Easy to Get an Unsecured Loan?

It’s easy to get an unsecured loan as long as you have decent credit. The underwriting process is simple and fast. You may even find lenders that will fund your loan on the same day. If you have less than perfect credit, you may find it easier to get a loan from an online or peer-to-peer lender.

Can You Get a Bad Credit Unsecured Loan?

There are always solutions for those with bad credit, including bad credit unsecured loans. Just prepare yourself, though – the interest rates and fees are high. Lenders are all about giving everyone a chance, but they need to protect themselves too. Since people with bad credit are at a higher risk of default, banks charge much higher rates and fees to protect themselves.

Bottom Line: Unsecured Loans

Unsecured loans can be a great option when you need a small loan, and you need it fast. While putting collateral down might help keep your rates low, if you have great credit and only borrow the money for the short term, you may get an attractive interest rate and get the funds you need fast.

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Kim Pinnelli
Kim Pinnelli

Kim Pinnelli is a Senior Writer, Editor, & Product Analyst with a Bachelor’s Degree in Finance from the University of Illinois at Chicago. She has been a professional financial writer for over 15 years, and has appeared in a myriad of industry leading financial media outlets. Leveraging her personal experience, Kim is committed to helping people take charge of their personal finances and make simple financial decisions.