What Is An Unsecured Loan And Should You Use One?

If you need extra funds to cover a big bill or a fun outing, consolidate credit card debt or start a home renovation, an unsecured loan can be a great option. Unlike some other types of loans, an unsecured loan doesn’t require a borrower to pledge an asset – such as a house or car – as collateral for the loan.

However, potential unsecured loan borrowers should be aware of certain requirements and risks that this type of loan carries.

Let’s walk through a few of them so you can be as informed as possible.

An unsecured loan is a type of financing that doesn’t require borrowers to put down any collateral. Instead, lenders approve unsecured loans based on the borrower’s creditworthiness – essentially, their credit profile and financial situation.

Common examples of unsecured loans are personal loans and credit cards (which are both typically unsecured), and student loans.

Unsecured Loans Vs. Secured Loans

The primary difference between unsecured and secured loans is the need for collateral – secured loans need it, and unsecured loans don’t.

Secured loans, such as auto loans, home equity loans and home equity lines of credit require borrowers to put down a valued asset as security for the terms of the loan. That way, the lender can take possession of the promised asset if the borrower defaults on the loan.

Since secured loans are considered less risky for lenders, most people can expect higher borrowing limits and more favorable loan conditions. This is opposed to unsecured loans, which replace the need for collateral with a higher interest rate, which could still be reasonable if your credit score is in good shape.

Unsecured loans are based solely on creditworthiness, so lenders need to ensure you’ll be able to fulfill the loan agreement. Most lending institutions require potential borrowers to submit a thorough application with information about their credit, income and monthly debt payments.

Your annual percentage rate (APR) is determined largely by your credit score, and a reasonably good interest rate typically requires a minimum score of 650. While you could still qualify with a lower score, you’ll likely see a high interest rate.

Unsecured loans are available through most lending institutions, unless otherwise stated. You can apply for an unsecured loan with:

• Online lenders
• Traditional banks
• Credit unions

If you’ve been a longtime customer with your bank or credit union, you may be able qualify for certain discounts if you apply with that institution.

Unsecured loans are either no-collateral installment loans or revolving lines of credit. They include an array of financial products, which we’ll break down in just a second.

Unsecured Personal Loans

A personal loan allows borrowers to receive funding for numerous financial issues or purchases. You can use a personal loan for:

• Debt consolidation
• Home improvement projects
• Emergency auto repairs
• Unplanned medical bills
• Buying a vehicle
• Starting a small business

Personal loans from Rocket Loans℠ vary in size from $2,000 to $45,000. Your repayment term on a personal loan will depend on your lender, but repayment terms typically fall somewhere in the 12- to 60-month range.

Unsecured Credit Cards

Credit cards provide a predetermined line of credit for borrowers to use for any purpose or purchase. Like most personal loans, most credit cards are unsecured. Secured credit cards require an upfront cash deposit, while unsecured cards don’t.

Credit cards will often carry a higher interest rate than a personal loan, with the average APR for credit cards hovering around 28% at the end of the first week in May 2024. The average APR for personal loans tends to be a little more than half as much.

Peer-To-Peer Loans

In recent years, peer-to-peer lending (or P2P lending) has become a popular way to access funding without going through traditional lending providers, such as a bank or a credit union. This process can range from borrowing money from a friend or relative to seeking out an investor by way of an online P2P lending platform.

Student Loans

Education loans are used for the express purpose of funding educational endeavors and expenses. Student loans usually carry more restrictions and repayment instructions than other types of unsecured loans.

Personal Lines Of Credit

A personal line of credit is an example of a revolving loan, which means the loan can be spent, repaid and spent again. A personal line of credit is similar to a credit card and usually carries a variable interest rate.

Unsecured loans are ideal financing options for borrowers uncomfortable putting up collateral, whether that’s a house, car or another other valuable asset. An unsecured loan may be the right choice if:

• You have a good credit score: Since unsecured loans depend so heavily on your credit history, those with a good or excellent credit score will likely qualify with the best interest rate and repayment term. Those with a poor credit score could struggle to qualify for a loan at all.
• You have reliable income: You’ll likely need a steady flow of cash in your checking account in order to make your loan payments on time. Having some cash in a savings account for backup is also ideal. Lenders also look at your debt-to-income ratio (DTI) when reviewing your finances.
• You want to consolidate credit card debt: Using an unsecured loan as a debt consolidation loan can help you pay down credit card debt and improve your personal finances. You can potentially save money if you qualify for a lower interest rate on your debt consolidation loan than you had on your credit cards.
• You want to make a big purchase: Whether planned or unplanned, an unsecured loan can finance the purchase of new home appliances, necessary repairs or other large expenses. With an unsecured loan, the purchased item won’t be collateral for the loan.

If your credit score isn’t high enough to qualify for a good interest rate, you may still meet the requirements for unsecured loan approval.

As with any loan, comparing the benefits and drawbacks of an unsecured loan is necessary to determine whether this option fits your needs and lifestyle.

Pros

Using an unsecured loan carries the advantages described next.

No Collateral Requirements

Since unsecured loans don’t have a collateral requirement, you don’t have to temporarily give up a personal belonging to secure the loan. And, if you default on the loan, the lender can’t sell an asset you gave up to recoup their losses.

Shorter Funding Time

Most lenders provide funding within a few days to a week of loan approval. At Rocket Loans, we can sometimes even offer qualifying borrowers the funding they need as early as the same day.¹ If you need funds fast for an emergency expense, an unsecured loan could be the best option.

Consistent Monthly Payments

Using an unsecured loan with a fixed interest rate means you’ll have a consistent monthly payment. And, if you have steady income that’s enough to cover the payment, building this payment into your budget should be pretty straightforward. On the other hand, if you use financing with a variable rate, your monthly payment amount is apt to change.

Cons

On the negative side, unsecured loans come with the disadvantages discussed below.

A Potentially High APR

The APR of a loan is the total cost, which includes the interest rate and any additional fees. With the APR of any loan, lower is better. But, as mentioned, unsecured loans can come with a higher interest rate and APR – especially if you have poor credit. That means using an unsecured loan could be more expensive than a secured option.

The Possibility Of A Variable Interest Rate

Not all unsecured loans come with a fixed interest rate and a consistent monthly payment. If you use a personal line of credit or a credit card, your interest rate will most likely change in tandem with current market rates. So, if interest rates climb, the same will likely be true of your monthly payment.

Origination Fees

Some lenders charge a one-time origination fee to cover the cost of processing a loan application. Origination fees typically range from 1% to 10% of the loan amount. Since origination fees are a one-time charge, they won’t affect your budget significantly. However, you should still budget for this charge when weighing loan options.

If you’ve decided to use an unsecured loan, you can take the following steps to apply:

1. Check your credit profile: Your first move should be to review your credit report. Also, check your credit score to see if it can qualify you for an unsecured loan. This is particularly important in light of how closely lenders look at your credit profile when deciding whether to approve a loan.
2. Determine your loan amount: Before you can apply for a loan, you should calculate the total dollar amount you need. Make sure the amount you apply for is enough for your desired purchase or expense.
3. Find the right lender for you: Research different types of lending institutions and platforms to find out which is going to be the best fit for your situation.
4. Prequalify to compare offers: Getting prequalified for a loan can give you an estimation of what you’ll qualify for with a particular lender. Consider prequalifying with multiple lenders so you can compare interest rates, APRs and monthly payment amounts.
5. Submit an application: Once you’ve picked an unsecured loan product that fits your needs, you can fill out an application and submit it to the lender. Be sure to provide all the necessary documentation.
6. Receive the funds: If you’re approved, your lender will notify you of when and how you’ll receive the loan. Usually, the funds are delivered in a lump sum to your bank account within 1 – 7 business days of approval.

See the answers to the frequently asked questions below to learn more about unsecured loans and their key features.

Can I get an unsecured loan with bad credit?

While a good or excellent credit score will typically get you at least a decent interest rate, it’s possible to still be approved for an unsecured loan with a score as low as 610 – 640. With a low credit score, though, you’ll likely have a higher interest rate.

What happens if I don’t pay off my unsecured debt?

If a borrower defaults on an unsecured loan, their credit score will take a big hit and the effects will be long-lasting. A loan default can remain on a borrower’s credit report for up to 7 years.

The lender may also accelerate the loan’s repayment, meaning the entire balance will be due immediately in the form of a balloon payment. If the borrower fails to make the full repayment, their debt may be sold to a collection agency.

Should I use an unsecured loan?

This loan option is optimal for people who have a major expense, a reasonable DTI and a high credit score. These borrowers will likely receive at least a modestly low interest rate, making the monthly payments more manageable.

If your credit score is lacking, a lender is likely to stick you with a higher interest rate – assuming you’re actually approved. A higher rate can make it harder to afford the monthly payments, putting your credit score at further risk.

If you’re concerned about making payments in full and on time, consider improving your credit score before applying for an unsecured loan.

Unsecured loans come in several forms and can offer numerous benefits to borrowers looking to consolidate their debt, make a large purchase or finance a home improvement project without using their property as collateral. Without you offering collateral to secure the loan, lenders will pay closer attention to your credit score and overall credit profile, though.

Make sure your credit score meets a lender’s eligibility requirements and is high enough to qualify for a good interest rate.

If you’re interested in an unsecured personal loan, visit Rocket Loans to start the loan approval process today.

¹Same-Day Funding available for clients completing the loan process and signing the Promissory Note by 1:00PM ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same-day funding, but results may vary and your bank may have rules that limit our ability to credit your account. We are not responsible for delays which may occur due to incorrect routing number, account number, or errors of your financial institution.