Unsecured Loans: What They Are And How To Pick One

Unsecured loans aren’t guaranteed or backed by any form of collateral. This is different from a secured loan, such as a mortgage or car loan. Secured loans put your car, home, or savings at risk in the event of nonpayment. If you’re hoping to acquire an unsecured loan that comes with a competitive interest rate, you will usually need to have a good credit score and/or a solid financial picture. Unsecured loans can be good options to fund a variety of financial needs such as consolidating debt or committing to a large purchase.

Let’s review what an unsecured loan is, how they work and when they might be useful.

What Are Unsecured Loans?

An unsecured loan is provided by a lender without any collateral required from the borrower. With an unsecured loan, the lender provides the loan offer largely based on your credit worthiness, including your credit score.

Since there’s no collateral, unsecured loans are generally considered riskier for the lender. Because of that, you’ll need to have a relatively high credit score to obtain attractive loan terms (like a lower interest rate).

Unsecured loans can often be put toward a variety of different purposes from consolidating and paying down debt to funding home upgrades and paying medical bills. However, certain lenders may restrict the number of purposes to which your loan can be applied. Before accepting the terms, be sure to read the fine print.

Here are a few examples of unsecured loans:

• Unsecured credit cards
• Personal loans
• Signature loans
• Student loans
• Peer-to-peer loans

How Do Unsecured Loans Work?

Unsecured loans allow you to borrow money without collateral and pay it back in monthly payments. Collateral is property that you pledge to give up if you are not able to repay your loan.

With an unsecured loan, you do not provide the lender with any collateral — instead, your application will be evaluated based on your income, credit history and other financial information. If you are wondering how to get a personal loan or other type of unsecured loan, typically you will apply and give the lender access to your credit report and financial information. They will then use that information to decide whether to grant you an unsecured loan, and with what terms.

Types Of Unsecured Loans

Personal Loans

A personal loan is among the most common forms of unsecured loan, and can provide rapid access to money that you can apply to all your financial needs. Generally, with a personal loan, the lender will allow you to use a personal loan to fund anything from debt consolidation to a wedding. Using a personal loan as a debt consolidation loan can roll different debt payments into one loan with a single monthly payment and a lower interest rate.

Credit Cards

Unsecured credit cards can be used to pay for almost anything and are one other type of unsecured loan. Credit cards are unsecured loans that are different from other types of loans because instead of receiving a lump sum, you'll have access to a line of revolving credit.

Student Loans

Student loans are another common form of unsecured loan utilized by millions of borrowers every year. Education loans are specifically intended to fund students’ education expenses and usually come with more restrictions attached than other types of unsecured loans. Another difference is how student loan repayment works — it usually comes with more restrictions than repayments on other types of personal loans.

Consolidation Loans

Another type of unsecured loan is a debt consolidation loan. If you aren't sure what a consolidation loan is, it's a type of loan where you take several different debt payments and roll them into one consolidated loan. You are often able to lower your overall interest rate and your monthly payment amount, allowing you to pay down your debt sooner.

Peer-To-Peer Loans

A peer-to-peer loan is another type of loan where individuals lend money to others. Peer-to-peer lending can come in a variety of forms: from online platforms that pair individuals willing to loan money with peers, to loans issued by family and friends. Peer-to-peer lending may come with additional risk for both parties since it often does not come with any governmental or regulatory oversight.

How To Select An Unsecured Loan

1. Check Your Credit Score

One of the first things you'll want to do if you're considering applying for an unsecured loan is to check your credit score. If you're not sure what a good credit score is, most lenders put your credit score into one of a few different ranges. Excellent credit is a FICO® Score above 800, while Good credit is between 740 and 799. Knowing your credit score can help you know what kind of loans you might qualify for.

2. Consider The Type Of Loan You Need

There are several different types of unsecured loans, so the next step is to decide which type of unsecured loan you need. Some unsecured loans are for specific purposes like debt consolidation or education expenses, while other unsecured loans can be used for just about any purpose.

3. Research Loan Providers

It's often a good idea to research and compare quotes from several different lenders. Researching lenders can include reading online reviews as well as getting recommendations from trusted friends and family. Getting quotes from several different lenders can help you compare rates and terms and find the best loan for your specific financial situation.

4. Apply For A Loan

Once you've decided on the lender and loan type that works best for you, it's time to apply for your loan. Make sure you've gathered all your financial information before applying to help streamline the application process. Another thing to keep in mind when applying for a loan is that the lender will typically make a hard inquiry on your credit report, which can affect your credit score.

FAQs About Unsecured Loans

What’s the difference between an unsecured loan and a secured loan?

The difference between an unsecured loan and a secured loan is primarily that a secured loan is backed by collateral, such as your car or home. If you default on a secured loan, the lender has the right to take the collateral on the loan, such as repossessing your car or foreclosing on your home. With an unsecured loan, the main downside if you default will be a negative mark on your credit report.

How can I qualify for an unsecured loan?

When you apply for an unsecured loan, lenders will make decisions on the basis of your overall creditworthiness and financial situation. That means that it’s important before applying to make sure that your credit score, debt-to-income ratio, and credit history are strong enough to secure competitive terms and rates. The higher your credit score and the stronger your financial picture, the better terms you are likely to get.

What are the alternatives to unsecured loans?

If you are looking for other options besides an unsecured loan, you have a few options to consider. Some alternatives to an unsecured loan include a retirement plan loan or a mortgage refinance.

What happens to an unsecured loan if I can’t pay it back?

If you default on an unsecured loan or are not able to make the monthly payments, a few things are likely to happen. First, your lender may assess late fees or other charges. As a last resort, the lender may mark your loan as in default, send it to collections and/or place a negative mark on your credit report.

The Bottom Line

An unsecured loan differs from a secured loan in that unsecured loans do not require you to put up any collateral to apply for the loan. In many cases, unsecured personal loans can present a better option for borrowers than inadvertently running up high levels of credit card debt. Paying off these types of loans can even prove more helpful for you in the long run by helping to boost your credit score. There are several types of unsecured loans available, so make sure you understand the options so that you can choose the right one for you.

If you're exploring getting an unsecured loan and want to better learn about your credit score and overall financial health, download the Rocket Money^SM app today.