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 might be your best bet.

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 – mainly their credit history and financial status. Common examples of unsecured loans are personal loans (which are most often unsecured), student loans and credit cards.

Before you hit the “apply” button, let’s take a closer look at how unsecured loans work and how you can use them.

As mentioned above, an unsecured loan is by definition a loan that doesn’t require a borrower to pledge assets – such as a house or car – as collateral for the loan. These loans are approved and granted based on the borrower’s credit score, income level and how much outstanding debt they owe.

Unsecured Loans Vs. Secured Loans

To understand unsecured loans, you must know how they differ from secured loans. The primary difference between the two is the need for collateral – secured loans need it, and unsecured loans don’t.

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

Since secured loans are considered less risky for lenders, most people can expect higher borrowing limits and more favorable loan terms. This is opposed to unsecured loans, which replace the need for collateral with a higher interest rate.

Unsecured loans are either no-collateral installment loans or revolving lines of credit, which means lenders don’t have a way to offset their risk. This is why most lending institutions require potential borrowers to submit a thorough application with information about their credit, income and monthly debt payments. Unsecured loans are based solely on creditworthiness, so lenders need to ensure you’ll be able to fulfill the loan agreement.

Since most financial institutions require that borrowers have a high credit score to get an unsecured loan, some lenders will allow people with limited credit to bring on a co-signer. It’s common, for example, for young people to add a parent or guardian as a co-signer to their student loan or first credit card. However, not all lenders accept co-signers. For instance, Rocket Loans^SM doesn’t use this option.

It’s also important to know that, while some lenders restrict how the unsecured loan can be spent, the option remains popular for its ability to successfully finance a wide variety of goals. For example, qualified borrowers can use an unsecured loan to complete a large purchase, consolidate debt or even start a personal credit line.

Unsecured loans include an array of financial products, such as unsecured personal loans, unsecured credit cards, student loans and revolving lines of credit. Let’s learn more about their suggested uses.

Personal Loan

A personal loan is exactly that – personal. It’s a general-use loan that allows borrowers to receive funding for numerous financial issues or purchases. At Rocket Loans, we enable qualified borrowers to get a personal loan with a wide range of loan amounts to best suit their situation – from debt consolidation to home improvement.

Unsecured Credit Card

This type of credit card provides a predetermined line of credit to borrowers, who can use that credit line for any purpose or purchase. Unsecured credit cards are also a great strategy for building better credit.

Peer-To-Peer Loan

In recent years, peer-to-peer lending has become a popular way to access funding without going through traditional lending providers, like 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 peer-to-peer lending platform.

Student Loan

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

Personal Line 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.

Whether you should seek an unsecured loan will depend on your personal situation and how you want to use the funds. If you’re trying to do one of the following, an unsecured loan may be the right choice:

• Pay for an emergency expense: Sometimes an unexpected bill shows up and you might not have enough in your bank account to pay
• Consolidate debt: Combining your debt into one loan payment can simplify your expenses and may even save you money if you can secure a lower interest rate.
• Fund a home improvement project: You could use an unsecured loan instead of a home equity loan to avoid putting your house up as collateral.
• Make a large purchase: If you have good credit and want to buy an appliance or make repairs to your vehicle, you could apply for an unsecured loan instead of digging into your savings.

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. Up next are some of the positive and negative unsecured loan features that borrowers should evaluate before committing to this form of financing.

Pros

Using an unsecured loan carries the advantages described below.

No Collateral Requirements

Since unsecured loans don’t have a collateral requirement, you don’t have to give up a personal belonging to secure the loan. This also means, if you default on the loan, the lender can’t take possession of an asset 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 even offer qualifying borrowers personal loan funding as early as the same day.* 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 rate means you’ll have a consistent monthly payment. And if you have steady income that’s enough to cover the payment, building this into your budget should be pretty straightforward. On the other hand, if you use financing with a variable rate, you most likely won’t have a consistent monthly payment amount.

Cons

Unfortunately, unsecured loans can also come with the disadvantages we’ll consider next.

Higher Annual Percentage Rates (APRs)

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

Variable Interest Rates

Not all unsecured loans come with a fixed interest rate and consistent monthly payment. If you use a personal line of credit or a credit card, your interest rate will most likely change with current market rates. That means, if interest rates climb, your monthly payment could increase, too.

Origination Fees

Some lenders charge a one-time origination fee to cover the cost of processing your 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.

Like most types of loans, unsecured loans are available at banks and credit unions as well as through online lenders. If you’ve decided to use an unsecured loan, you can take the following steps to apply:

1. Determine the loan amount. Before you can apply for a loan, you should calculate the total dollar amount you need.
2. Find the right lender for you. Research different types of lending institutions and platforms to find out which offers the option that works best for your situation.
3. Compare offers. Collect information about each loan option and compare their interest rate, APR and monthly payment.
4. 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.
5. Receive the funds. After you get approval, your lender will notify you of when and how you’ll receive the loan.

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?

If you have excellent credit, you’ll probably have few difficulties being approved for an unsecured loan. However, if you’ve had financial hardships like bankruptcy or foreclosure, approval could be challenging if not impossible. Before applying for an unsecured loan, it’s best to take steps to increase your credit score if it could stand a boost.

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 10 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 debt-to-income ratio (DTI) and a high credit score. These borrowers will likely receive a lower 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 may make it more difficult 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.

If you’re ready to take the next step in the approval process, visit Rocket Loans to apply for a personal loan.

*Same 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.

*Same 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.