What is a signature loan?

What is a signature loan and how do they work?

A signature loan is an unsecured personal loan the borrower can use for nearly any purpose. However, some lenders may have usage restrictions, and many will not allow loans to be used for down payments or investing. People often use signature loans to pay for vacations, consolidate debt, fund education or make home improvements.

Terms on signature loans last from a few months to a few years.

You can get a signature loan from pretty much any bank or credit union. There are also several reputable online lenders that provide signature loans. Once approved, you can electronically sign the required documents and receive the funds in your bank account within a few hours up to a few days, depending on the lender.

Signature loans require you to pay back the amount you borrow over time plus interest. Your credit score, history with the lender, income and other debts may help a lender decide whether to approve your application and how much interest to charge.

Expect to be charged fees, such as an origination fee, which typically come out of the funds you receive. Lenders may also impose prepayment penalties, which help ensure they receive a certain amount of interest even if you choose to pay off the loan early.

Signature loan terms can range from a few months to a few years. Some lenders let you choose your loan term length and repayment schedule. You may pay a slightly lower interest rate if you choose a loan with a shorter term.

“Agreeing to a shorter personal loan term often results in securing a lower interest rate because the lender will get their money back from you faster, which means you'll have less time to default,” said Leslie Tayne, the founder and head attorney at Tayne Law Group. “The lender can afford to reward you for the reduced risk.”

» MORE: Personal loan vs. credit card: Which is better?

How to get a signature loan

Getting a signature loan starts with an application. Many lenders provide online applications with just a few general questions about your identity and financial situation. You may be able to get preapproved for a signature loan with only a soft credit pull, but if you accept the loan terms and want to move forward, you'll need to grant permission for a hard credit check.

When a lender pulls your credit to provide final approval for a signature loan, the action will appear as an inquiry on your credit report. It’s important to note that new credit inquiries could reduce your credit score temporarily by a few points.

If your application is denied, the lender must provide written communication that explains its decision.

Here's some of the information a lender may require in a signature loan application:

• Your full legal name
• Your driver's license number
• Your Social Security number
• Your mailing address
• The name and address of your employer
• Your most recent pay stubs
• Your most recent tax returns

If your application is denied, you have a right to know the specific reason. You’re also entitled to free copies of the credit reports the lender used to justify their denial.

The next steps after loan approval

If your application is approved, you'll receive documents to sign to start delivery of the funds. Before accepting the loan, make sure you do the following:

• Read the fine print for additional fees.
• Check your annual percentage rate (APR), monthly payment and information about the first payment.
• Get your bank account routing and account numbers ready for the fund transfer.

You can change your mind about the loan anytime before signing the final approval.

» MORE: Best personal loans with a co-signer

Pros and cons of a signature loan

For borrowers with good credit, signature loans can provide several benefits, including lower interest rates and zero or low fees. A signature loan doesn't require collateral, which is a major plus for many borrowers.

If you have bad credit or haven't had a lot of experience with loans or credit cards, you may have trouble getting a signature loan with good terms and a low interest rate, though.

Bottom line

For some borrowers, a signature loan can be a powerful tool to help propel them toward their financial goals. For others, it can make a bigger mess out of a problematic money situation.

If you need quick access to cash and have the credit and income to qualify for a signature loan with a low interest rate, it could be a good option. However, it's important to shop around for the best possible rates and fees.