What is an unsecured loan?

An unsecured loan is a loan not backed by an asset. This means that if you fail to pay back the loan, there is no collateral the lender can take (like your house or car) to sell and recover its loss. Because lenders view them as riskier, unsecured loans generally have stricter requirements for qualification, lower borrowing limits and higher rates.

How do unsecured personal loans work?

Unsecured personal loans are often called signature loans because the only thing guaranteeing the loan is the borrower’s signature. You can get an unsecured personal loan from a bank, credit union or online lender, usually in a lump sum amount ranging from under $100 to $50,000 or more.

Before approving you for an unsecured loan, a lender typically checks your credit report, credit score, proof of income and other documents to evaluate whether you have the financial ability to repay the loan.

If you're approved for the loan, you can generally use the money for whatever you want. You then make regular payments back to the lender — usually every month — until the end of the loan term (or earlier, if you pay back the loan in full). Your payment consists of a portion of the principal (the original amount borrowed) and interest (the cost to borrow).

Types of unsecured loans

There are numerous types of unsecured loans, including:

• Personal loan: A personal loan lets you borrow money for use toward any purpose and pay it back in regular installments. A personal loan usually has a fixed interest rate.
• Personal line of credit: With a line of credit, you can continually access money as needed up to a specific limit. You receive a monthly bill with a balance and only pay interest on the amount that you withdraw.
• Credit card: A credit card, like a personal line of credit, is a type of revolving credit, which means you can repeatedly borrow and pay back money up to a limit as long as your account is open. A credit card is different from a personal line of credit because you have a physical card to use instead of funds that are deposited in your bank account.
• Student loans: Most educational loans are unsecured loans, and student loans can be backed by the federal government or a private lender. These have key differences from other types of unsecured loans, like whether a credit check is required, whether the tax on interest is deductible, when payments are due and the variety of repayment plans.

You can use unsecured loans for a variety of reasons. These might include:

• Consolidating debt into one loan with a single monthly payment and lower interest rate
• Renovating a home
• Funding a college education
• Buying a new appliance
• Paying for a wedding
• Getting professional movers
• Going on a vacation
• Dealing with an emergency expense

How to get an unsecured loan

Most lenders, including banks and credit unions, offer unsecured loans. There are also online lenders that offer unsecured loans. Qualifying for an unsecured loan can be difficult for some borrowers, however. It's worth comparing several lenders to find one that offers what you're looking for with the best possible terms.

To verify that you are an acceptable credit risk for an unsecured loan, lenders consider these factors:

• Income: You may need to provide pay stubs and W-2s that prove your income is sufficient.
• Employment: Lenders want to know you’re actively employed and have a history of consistent employment.
• Credit history: Your credit report and credit score play a big role in a lender’s decision. You need a FICO score of at least 670 or so to be able to borrow from the broadest number of lenders at relatively low interest rates.
• Assets: Though unsecured loans don’t require any assets as collateral, the lender may want to see further proof that you have the financial ability to make your payments in case your income suddenly drops.
• Debt-to-income ratio: Your debt-to-income (DTI) ratio is the ratio of your monthly debts to your gross monthly income. Lenders prefer a DTI ratio of about 36% or less for personal loans.

Each lender sets its own qualifications for borrowing an unsecured loan. A lender might disclose general or even specific guidelines for income, credit score and DTI upfront, but in many cases, it weighs all these factors together to make an approval decision. You can usually pre-qualify for an unsecured loan without a hard credit check.

How to get an unsecured loan with bad credit

It can be a bit more difficult to get an unsecured loan if you have bad credit. Every lender sets its own credit score requirement — some disclose the minimum score a borrower needs so you can know right away if you are eligible for a loan.

Some unsecured loans are designed specifically for borrowers with bad credit. These loans commonly have low borrowing limits and high interest rates and fees, so consider the terms of any agreement carefully before signing. You may want to consider an alternative, like borrowing from a friend or family member or getting a secured loan.

Pros and cons

The biggest benefit of an unsecured loan is that it doesn’t require collateral that the lender can take if you default on the loan. On the flip side, unsecured loans are more difficult to get than secured loans, and the interest rates are higher.

Bottom line

Unsecured loans have many advantages — the biggest being that you don’t risk losing a valuable personal asset if you can’t repay the loan. These loans tend to have a simple application process and give you fast, flexible use of funds. There are some drawbacks, though, such as tougher eligibility requirements and higher interest rates than secured loans.

If you decide an unsecured loan is right for you, be sure to compare details of offers from several lenders, including how much you can borrow, the annual percentage rate, the monthly payment amount, fees and customer service.