What Is an Unsecured Personal Loan?

What is an unsecured loan?

An unsecured loan is a loan that doesn’t require collateral, like a car or savings account, for approval. Instead, lenders issue this type of personal loan based on information about you, like your credit history, income and outstanding debts.

Unlike with a mortgage or auto loan, if you don't repay an unsecured loan, a lender can't repossess any of your personal belongings, but your credit will take a hit.

You can use funds from an unsecured personal loan to pay for almost anything, but the best personal loan helps you achieve a financial goal without adding unmanageable debt.

If you’re considering an unsecured loan, learn the pros and cons, what they can be used for, where to get one, how to qualify and what happens if you don't pay it back.

» COMPARE: Our picks for the best unsecured personal loans

How do unsecured loans work?

Unsecured personal loans come in a lump sum — anywhere from $1,000 to $100,000 — and you repay them in equal monthly installments that include interest.

Annual percentage rates on unsecured personal loans range from about 6% to 36%. Borrowers with good to excellent credit (690 credit score or higher) will likely qualify for the lowest APR. Since the APR includes interest and fees, it reflects the overall cost of the loan.

For example, if you borrow $10,000 with a three-year repayment term at 15% APR, you’ll pay $2,480 in interest. The same loan with a 10% APR costs $1,616 in interest.

Repayment terms, ranging from two to seven years, also affect total interest. The longer the term, the more interest you’ll pay.

Lenders generally view unsecured personal loans as riskier than secured loans, which require you to pledge collateral to secure the loan. To balance that risk, lenders usually charge higher rates and have tighter borrowing requirements for unsecured loans than secured loans.

» MORE: Secured vs. unsecured loans: What's the difference?

What can you use an unsecured loan for?

Lenders may market unsecured personal loans for different purposes, but they can be used for almost any expense. Below are some of the most common.

Loans that improve your financial health: Home improvement and debt consolidation loans are two ways to use an unsecured personal loan that contribute to your financial goals. With a home improvement loan, you can make updates to your home that increase its value. With a debt consolidation loan, you can consolidate debts like credit cards under a lower interest rate, which helps you save money on interest and pay off the debt faster.

Loans for discretionary expenses: Though you can use an unsecured personal loan to fund a discretionary expense, like with a wedding loan or vacation loan, NerdWallet recommends using savings instead. If you need to finance this kind of expense, compare all your options, and only get a loan if it’s the cheapest financing option available.

Loans for unplanned expenses: Emergency loans can help you cover an unexpected expense, like a medical bill or car repair. Still, you’ll likely have cheaper alternatives in an emergency, like a medical payment plan or a local resource. If you urgently need a loan, look for a lender that offers fast funding, low rates and minimal fees.

» MORE: Top reasons to get a personal loan

Pros and cons of unsecured personal loans

As with any financial product, it’s important to carefully weigh the benefits and drawbacks before you apply and sign a loan agreement.

Pros of unsecured loans

• Faster approval: Expect to get your money more quickly with an unsecured loan than with a secured loan, which may require additional documents such as proof of title for a car.

• No collateral: Unlike with a secured loan, the lender can’t take your property if you stop making payments on an unsecured loan.

Cons of unsecured loans

• Potentially high rates: Unsecured loans are riskier for lenders than secured loans and therefore can have higher interest rates, especially for bad-credit borrowers.

• Default consequences: If you default on an unsecured loan, your credit score will be negatively affected. The remaining loan balance can be sold to a debt collection agency, prompting collections calls from an unfamiliar company, and you may be sued in an attempt to collect on the debt.

Where can I get an unsecured loan?

You can get an unsecured personal loan from an online lender, credit union or bank. These lenders will assess your ability to afford the loan and report payments to the three major credit bureaus — Equifax, Experian and TransUnion.

Online loans: Online lenders can give you an application decision in minutes, and some can deposit money directly into your bank account within a day or two. They also work with borrowers across the credit spectrum.

Credit union loans: Credit unions may provide better rates and more flexible terms for borrowers with fair or bad credit scores (669 score or lower). Though you’ll need to become a member of the credit union before applying, membership is typically quick and affordable.

Bank loans: If you already have an existing relationship with a bank, it’s worth checking whether it offers unsecured loans, since banks may offer larger loan amounts and lower rates for existing customers in good standing.

How to qualify for an unsecured personal loan

Here are some of the things a lender will review when deciding whether you qualify for a loan and at what rate.

Credit: Your credit score is a key factor in a loan decision. An excellent credit score can get you access to the lowest unsecured loan rates and largest loan amounts. Bad-credit borrowers who qualify will likely get the highest rates. Lenders also look at the length of your credit history. Many require borrowers to have at least two years of credit history, but longer is better.

Debt-to-income ratio: Lenders look at your debt-to-income ratio — which is your monthly debt payments as a percentage of your monthly income — to evaluate how burdened you already are with debt. Too much debt, and a lender may decide the risk that you’ll struggle to pay a loan back is too high. Most lenders prefer applicants with a DTI below 50%.

» MORE: Calculate your debt-to-income ratio

Bank account transactions: Some lenders look at your bank account to see how much money is coming in and going out. This helps a lender understand how loan payments would fit into your monthly budget.

How to apply for an unsecured loan

1. Check your credit. Check your credit report for any incorrect information, such as accounts that are incorrectly reported as delinquent or the same debt listed more than once, that could be dragging down your score.

2. Pre-qualify. Many lenders offer pre-qualification, a short process that involves submitting basic personal information and getting a preview of the loan you may receive within minutes. Pre-qualifying won’t hurt your credit score. You can pre-qualify with NerdWallet for free to see offers from multiple online lenders. 

3. Compare loan offers. Compare the offers from pre-qualification to select the option that’s best for you. The loan with the lowest APR is generally the best option, since it represents the least expensive loan.

4. Submit a formal application. Once you’re ready to apply, gather documentation, such as W-2s and bank statements, and complete an application with the lender you’ve chosen. The lender will perform a hard credit check at this time. Most lenders make approval decisions within a couple of days and can fund a loan within a week.

» MORE: How to get a personal loan

What happens if you default on an unsecured personal loan?

If you default on an unsecured loan, the most immediate impact will be to your credit score. A missed payment that’s more than 30 days late could cause your score to drop about 100 points and stay on your credit report for up to seven years.