Unsecured Loans: What They Are and How They Work

An unsecured personal loan lets you borrow money without having to pledge items you own as collateral.
What Is an Unsecured Loan?

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What’s inside

Unsecured loans do not require collateral, like a house or car, for approval. Instead, lenders issue these loans 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. The lender may instead file a lawsuit, but the majority of the hit will be to your credit.

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 and how to qualify.

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You borrow an unsecured loan in a lump sum, which can be between $1,000 and $100,000, and repay it, plus interest, in monthly installments.

Interest rates on unsecured personal loans range from about 6% to 36%. The APR on loans for borrowers with excellent credit is around 12%; it's about 29% for bad credit borrowers, according to an analysis of anonymized offers from users who pre-qualified using NerdWallet's lender marketplace.

The loan’s APR includes any upfront fees, including, which some lenders charge for processing a loan. Origination fees typically range from 1% to 10% of the loan amount. Other loan fees may include late fees, prepayment fees — where a lender charges you for early repayment — and fees for an unsuccessful payment.

Online lenders, banks or credit unions generally offer. These lenders will report payments to the three major credit bureaus — Equifax, Experian and TransUnion. On-time payments could improve your credit, while late payments are likely to hurt it.

Lenders may market unsecured personal loans for different purposes, like home improvement loans or wedding loans, but they share common features. They typically range from $1,000 to $50,000 and are repaid in fixed monthly installments over two to seven years.

Loans that improve your financial health: Home improvement and debt consolidation loans can contribute to your financial goals. With a , you can make updates to your home that increase its value. A debt consolidation loan with a low interest rate can be a less expensive way to pay down existing debt. These are among the best .

Loans for discretionary expenses: NerdWallet generally recommends saving for discretionary expenses like vacations. If you need to finance this kind of expense, you could get a lower rate on a personal loan than a credit card. Compare all your options, and only get a loan for these purposes if it’s the cheapest one.

Loans for unplanned expenses: Unsecured loans for things like emergencies and medical bills should be considered as a last resort. You likely have  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.

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You can get an unsecured loan from an online lender, bank or credit union. Each type of lender has its own set of benefits and drawbacks, and rates, terms and loan amounts vary.

When comparing loans from different lenders, consider the interest rate as well as the monthly payment. Use a to get estimated rates and payments based on your credit score.

Most online lenders offer , a short process that involves submitting basic personal information and, within minutes, getting a preview of the loan you may receive, including the loan amount, estimated rate and terms.

Online lenders usually do a soft credit check with pre-qualification, so your credit score won’t be affected.

Online is usually the fastest way to get a loan. These lenders can give you an application decision in minutes, and some can deposit money directly into your bank account within a day or two.

Credit unions are not-for-profit financial organizations that may provide better rates for borrowers with fair or bad credit scores (689 or below). Federal credit unions cap APRs at 18%.

However, shopping for can be more time-consuming than online loans, and there’s no option to pre-qualify.

You must also be a member of the credit union to be eligible for a loan. Membership typically requires living or working near the credit union or being associated with a particular group the credit union serves, and paying a small fee and one-time deposit up to $25.

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

The downsides are typically do not let you pre-qualify with a soft credit pull, they often accept only borrowers with strong credit scores and some require you to apply in person.

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

For many lenders, 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.

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Lenders also look at the length of your credit history. Many require borrowers to have at least two years of credit history, and the longer, the better.

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. Some lenders prefer applicants with a DTI below 40%.

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

Before you apply for a loan, pre-qualify to see what rates and terms lenders can offer you. You can to see offers from multiple online lenders. Pre-qualifying should never impact your credit score.

You can take those offers and compare them with loans that other lenders, like banks, may offer.

Once you’re ready to apply, you'll need to gather documentation, such as W-2s and bank statements, and begin the online or in-person application with the lender you’ve chosen.

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