There are many financing options for consumers who want to borrow money and two main lending categories: secured and unsecured debt. What are personal loans? They are unsecured financing and have several names:
- Personal loan
- Unsecured loan
- Signature loan
These terms all refer to the same type of borrowing.
Secured loans are those that require borrowers to pledge something of value that the lender can take if the borrower fails to repay the loan. This item is called “collateral.”
Often, the collateral is the item being financed. For example, if you take out a mortgage to purchase your home, the home itself serves as the collateral. The lender can foreclose, evict you and sell the house if you fail to make your payments. Similarly, an auto loan is generally secured by the car it finances.
Unsecured loans have no collateral for the lender to recover if you fail to repay them. So unsecured loan rates are higher than secured loan rates. The lender’s main form of security is your good word — your personal promise to repay.
What is a signature loan? It’s just another name for personal loan or unsecured loan, and it’s guaranteed by your signature. Most unsecured loans have shorter durations than secured loans. While you can get a mortgage for 30 years, personal loans typically have terms ranging between one and five years.
Unsecured loans come in four common forms:
- Signature loans provide a lump sum that you repay in monthly installments. Interest rates are generally fixed, and you can use the money for any purpose. The terms “personal loan” and “signature loan” are often used interchangeably. While signature/personal loans can be found in amounts ranging between $1,000 and $100,000, the most popular sources offer a range between $5,000 and $35,000.
- Personal lines of credit are also unsecured. However, unlike a personal loan or signature loan, these accounts are open-ended. Your lender approves a specific maximum amount of credit, and you are free to draw any amount up to your limit. The lender bases your monthly payment on the amount of credit used and your interest rate. Your interest rate can be fixed or variable.
- Credit cards are similar to personal lines of credit in that you can use and re-use them as long as you make your monthly payments.
- Student loans are technically unsecured. That’s because even though you use them to acquire an education, the lender can’t repossess your degree if you default.
Sources of personal, unsecured and signature loans
There are many types and sources of Personal loans; six common sources include:
- Your local bank. If you have terrific credit and a good relationship with your local bank, you might get a signature loan within hours.
- Online banks. If you want to be sure you are accessing the lowest possible interest rate, you may begin your search for a personal loan online, comparing offerings from various lenders to determine the most attractive rates and terms. This can be especially important if your credit is not well-established or “less than terrific” as terms can vary significantly.
- Peer-to-peer sites. These are popular sources of personal loans. In most cases, these loans come with fixed interest rates and payments.
- Student loans. You can only use student loans for education-related costs. However, student loans also carry benefits that other loans do not – like the ability to defer them until graduation, a choice of flexible repayment options and in some cases the opportunity to have them forgiven – if, for example, you get a teaching degree and agree to teach in an at-risk district. Your school’s financial aid office is a great place to start your search.
- Credit cards. These accounts are widely available and heavily-promoted. Be cautious about offers you receive by mail, online, and on the backs of buses. Sign-up bonuses and welcome offers can be enticing, but be clear on the ongoing terms after any welcome period.
- Personal lines of credit. Review the fine print carefully because the terms can be complicated – especially if your interest rate is variable.
Personal loans and your credit
Because lenders rely almost entirely on your word for repayment, your credit rating is more important when you apply for a personal loan than it is when you apply for secured financing.
Using FICO’s Credit Score Calculator, as of this writing, you can see a credit score’s impact on interest rates when comparing mortgage rates and personal loan rates for two consumers – one with excellent credit and one with fair credit.
|Mortgage interest rate||Interest rate for $25K personal loan|
|Good credit: 760||4.012%||7.7%|
|Fair credit: 660||4.625%||12.76%|
That difference of over 5 percent between personal loan borrowers is significant, while the mortgage rate impact is minimal.
Shopping for personal loans
How hard is it to get a signature loan? That depends on your credit and income. Solid applicants can receive their money in just hours and pay low interest rates. Unsecured personal loan rates rates vary widely. For instance, while the best deal listed for a consumer with a 660 FICO score may be 12.76 percent, other lenders advertise rates above 23 percent!
This is why it’s so important to shop carefully for personal loans. Mortgage rates, on the other hand, typically vary between .25 to .50 percent among lenders on a given day for the same borrower.
Can lenders force you to pay an unsecured personal loan?
When you fail to repay a secured loan, the lender can repossess the collateral. If you default on your auto loan, you may eventually look in your garage and find it empty. Ignore your mortgage lender’s pleas for payment? Don’t be surprised when a “foreclosure sale” sign goes up in your yard.
But what about unsecured creditors? Can you really just walk away?
Not likely. Unsecured lenders have four common solutions when borrowers default:
- Turn accounts over to a collection agency.
- Sell debt and let the new creditor try to collect.
- Report bad payment history to credit bureaus, making it harder for consumers to borrow in the future – and possibly impact the ability to buy insurance or get a job.
- Unsecured creditors can also sue you, obtain a judgment, and use that to garnish your wages, place a lien against your home, or force you into bankruptcy in some cases.
There are many great reasons to apply for a personal loan, but you do have to pay it back.