What Is an Unsecured Personal Loan?
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An unsecured loan is a loan that doesn’t require collateral, like a house or car, 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. 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.
» COMPARE: The best unsecured personal loans
How do unsecured personal loans work?
Unsecured personal loans work by lending you money in a lump sum — anywhere from $1,000 to $100,000 — which you repay 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 compared to borrowers with fair or bad credit (689 credit score or lower). Your APR includes interest and any fees, including origination fees, and determines how expensive the loan is.
For example, if you borrow $10,000 with a three-year repayment term at 15% APR, you’ll pay $2,480 in interest. If you take out the same loan at 10% APR, you’ll pay $1,616 in interest.
Repayment terms, ranging from two to seven years, also affect total interest. The longer the repayment term, the more interest you’ll pay.
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 personal loans
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.
Unlike with a secured loan, the lender can’t take your property if you stop making payments on an unsecured loan.
Borrowers with excellent credit scores may qualify for rates as low as those on secured loans.
Cons of unsecured personal loans
Unsecured loans are riskier for lenders and therefore can have higher interest rates, especially for bad-credit borrowers.
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.
What are unsecured personal loans used 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. A debt consolidation loan with a low interest rate can be a less expensive way to pay down existing debt.
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: Unsecured loans for things like emergencies and medical bills should be considered as a last resort. You 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.
Where can I get an unsecured personal loan?
You can get an unsecured personal loan from an online lender, credit union or bank, which all generally offer safe unsecured loans. These lenders will assess your ability to afford the loan and report payments to the three major credit bureaus — Equifax, Experian and TransUnion.
When comparing loans from different lenders, consider the interest rate as well as the monthly payment. Use a personal loan calculator to get estimated rates and payments based on your credit score.
Most online lenders offer pre-qualification, 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 do a soft credit check with pre-qualification, so your credit score won’t be affected.
Online lenders are 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. Federal credit unions cap APRs at 18% unless you’re applying for a short-term, small-dollar loan.
However, you’ll need to become a member of the credit union before applying for a credit union 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 one-time membership fee, which can be as little as $5.
If you already 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 existing customers in good standing.
Bank loans often come with higher credit score requirements, though, and some may require you to close the loan in-person.
» MORE: How do bank loans work?
How to qualify for an unsecured personal loan
Here are some of the things lenders will review when deciding whether you qualify for a loan and at what rate.
Credit: 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. 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.
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. Some lenders prefer applicants with a DTI below 40%.
Bank account transactions: 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.
Apply for an unsecured personal loan
Before you apply for a loan, pre-qualify to see what rates and terms lenders can offer you. You can pre-qualify with NerdWallet for free to see offers from multiple online lenders. Pre-qualifying does not 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 application with the lender you’ve chosen.