What is an unsecured loan? (2023)
An unsecured loan doesn’t require collateral. Learn about how this kind of loan works, the types and what to consider before getting one.
Sara Coleman
A personal loan provides funds you can use for just about anything. For example, you can use a personal loan to consolidate debt at a lower interest rate, complete home renovation projects or pay for an emergency expense.
Personal loans are widely available from banks, credit unions, online lenders and specialized lenders. It’s important to shop around and compare your borrowing options when considering what lender to use.
There are numerous options for personal loan lending, some of which are a better match for certain financial situations, such as quicker funding or lower approval criteria.
Before taking out a personal loan, consider how much you need to borrow and what you're comfortable paying each month. Then you can compare several lenders to get an idea of which is best for your exact needs.
Both community and nationwide banks offer options for personal loans. They often have larger loan amounts and better flexibility than other lending options — although rates may also be higher.
Most banks require a FICO score that falls within the good range (670-739) for approval, but you may be able to get a personal loan with a lower score if you have a relatively high income or low debt-to-income (DTI) ratio.
Some consumers prefer brick-and-mortar banks for the simple fact you can speak with someone in-person if you need a more personalized loan experience.
If you have an existing relationship with a bank, you might have a greater chance of approval.
Credit unions are not-for-profit businesses with a mission to serve their members. They are usually local and can be highly specialized, like for those who belong to a specific professional group. Most often, a credit union will offer the same financial products as traditional banks, including personal loans, but often at a lower cost because of its structure.
To borrow from a credit union, you must first become a member, which also has its benefits. Credit unions return their profits back to members in the form of higher savings rates, lower fees and lower lending rates.
They also offer personalized customer service — a reviewer from Florida said it was their credit union that referred them to a nonprofit debt counseling company that helped them out in their time of need.
Online lenders are some of the most flexible lenders out there. Many offer competitive rates and sizable amounts of money to those who can prove they can repay the debt. These lenders also make borrowing a personal loan convenient; you can apply, get a decision and get funds all on the same day in some cases.
But keep in mind there’s a difference between an online marketplace for loans and the actual institution lending you money. These popular websites connect potential borrowers to third-party lenders but aren’t the ones providing or servicing the loan. However, the marketplace can help you easily compare your options and find which personal loan is best for you.
The government doesn’t actually lend money directly for personal loans; instead, it uses private lenders to handle the loan application and servicing. The government merely guarantees the loan.
These loan programs — which are not necessarily personal loans — typically offer attractive interest rates and lower fees, but can be difficult to find.
Examples of these loans include federal student loans, housing loans for disaster relief or home improvements and business funding, such as small business loans through the Small Business Administration, to name a few.
Borrowing money from friends and family is another option for personal loans. It typically costs less in interest and fees (if they charge you anything at all), plus you avoid the paperwork and lengthy application process — but it’s not without risk.
While a family member or friend may not charge the interest rate and fees normally charged by a financial institution, if there are delays with your repayment or disagreements about the funds, it can create tension or conflict.
The best way to avoid this is to put everything in writing up front and clearly spell out the repayment terms and any potential interest.
How do you know which type of lender is right for your situation? Firstly, ask if you want in-person service; if you do, you can rule out online lenders.
Next, start comparing offers from lenders based on the following factors.
“When comparing lenders for a personal loan, a consumer should look beyond just the interest rates,” said Sammie Ellard-King, a personal finance advisor and founder of Up the Gains. “The lender's reputation, customer service, loan terms and prepayment penalties are all vital factors.”
A personal loan can help bridge the gap if you don’t have the funds for a larger purchase or major expense. While there are numerous reputable and reliable lenders, there are some you should avoid if at all possible, including:
“Be cautious about getting a personal loan from payday lenders or loan sharks, as these can have extremely high-interest rates and hidden fees,” warned Ellard-King.
» MORE: 11 payday loan alternatives
APRs can vary significantly depending on the type of loan. For example, as of May 2023, the average rate on credit cards was around the 20% mark, while the average interest rate on two-year personal loans from commercial banks was around 11%, according to the Federal Reserve. Consumers with excellent credit scores will likely receive the lowest APR, while those with a lower credit score pay higher interest rates.
Each lender has different criteria for approval, but typically it’s easier to qualify for secured loans versus unsecured loans. Secured loans require collateral, which is an asset the lender can take possession of if you default on a loan. Since a lender can recoup some of its funding this way, the loans are considered less risky and easier to qualify for.
The credit score needed varies depending on the lender, but there are some lenders for bad credit that only require a credit score of 580 for qualification. Just keep in mind that with these loans, the interest rates are typically higher.
One of the advantages of a personal loan is you can use the funding for almost anything, such as debt consolidation, home improvements, a wedding or household expenses. Some lenders do place restrictions on the use of funds, such as for investing or educational expenses.
Choosing the best personal loan for you means comparing options from different kinds of lenders, including banks, credit unions and online companies. Banks and credit unions provide in-person customer service and may have special offers for account holders, while online lenders often make applying and borrowing convenient and fast.
Start by looking for lenders that let you pre-qualify without a hard credit check so you can see potential terms without any negative effect on your credit score.
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