What Is An Unsecured Loan And Should You Use One?

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 – essentially, their credit profile and financial situation.

Common examples of unsecured loans are personal loans and credit cards (which are both typically unsecured), and student loans.

Unsecured Loans Vs. Secured Loans

The primary difference between unsecured and secured loans is the need for collateral – secured loans need it, and unsecured loans don’t.

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

Since secured loans are considered less risky for lenders, most people can expect higher borrowing limits and more favorable loan conditions. This is opposed to unsecured loans, which replace the need for collateral with a higher interest rate, which could still be reasonable if your credit score is in good shape.

Unsecured loans are based solely on creditworthiness, so lenders need to ensure you’ll be able to fulfill the loan agreement. Most lending institutions require potential borrowers to submit a thorough application with information about their credit, income and monthly debt payments.

Your annual percentage rate (APR) is determined largely by your credit score, and a reasonably good interest rate typically requires a minimum score of 650. While you could still qualify with a lower score, you’ll likely see a high interest rate.

Unsecured loans are ideal financing options for borrowers uncomfortable putting up collateral, whether that’s a house, car or another other valuable asset. An unsecured loan may be the right choice if:

• You have a good credit score: Since unsecured loans depend so heavily on your credit history, those with a good or excellent credit score will likely qualify with the best interest rate and repayment term. Those with a poor credit score could struggle to qualify for a loan at all.
• You have reliable income: You’ll likely need a steady flow of cash in your checking account in order to make your loan payments on time. Having some cash in a savings account for backup is also ideal. Lenders also look at your debt-to-income ratio (DTI) when reviewing your finances.
• You want to consolidate credit card debt: Using an unsecured loan as a debt consolidation loan can help you pay down credit card debt and improve your personal finances. You can potentially save money if you qualify for a lower interest rate on your debt consolidation loan than you had on your credit cards.
• You want to make a big purchase: Whether planned or unplanned, an unsecured loan can finance the purchase of new home appliances, necessary repairs or other large expenses. With an unsecured loan, the purchased item won’t be collateral for the loan.

If your credit score isn’t high enough to qualify for a good interest rate, you may still meet the requirements for unsecured loan approval.

If you’ve decided to use an unsecured loan, you can take the following steps to apply:

1. Check your credit profile: Your first move should be to review your credit report. Also, check your credit score to see if it can qualify you for an unsecured loan. This is particularly important in light of how closely lenders look at your credit profile when deciding whether to approve a loan.
2. Determine your loan amount: Before you can apply for a loan, you should calculate the total dollar amount you need. Make sure the amount you apply for is enough for your desired purchase or expense.
3. Find the right lender for you: Research different types of lending institutions and platforms to find out which is going to be the best fit for your situation.
4. Prequalify to compare offers: Getting prequalified for a loan can give you an estimation of what you’ll qualify for with a particular lender. Consider prequalifying with multiple lenders so you can compare interest rates, APRs and monthly payment amounts.
5. 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. Be sure to provide all the necessary documentation.
6. Receive the funds: If you’re approved, your lender will notify you of when and how you’ll receive the loan. Usually, the funds are delivered in a lump sum to your bank account within 1 – 7 business days of approval.

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?

While a good or excellent credit score will typically get you at least a decent interest rate, it’s possible to still be approved for an unsecured loan with a score as low as 610 – 640. With a low credit score, though, you’ll likely have a higher interest rate.

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 7 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 DTI and a high credit score. These borrowers will likely receive at least a modestly low 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 can make it harder 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. Without you offering collateral to secure the loan, lenders will pay closer attention to your credit score and overall credit profile, though.

Make sure your credit score meets a lender’s eligibility requirements and is high enough to qualify for a good interest rate.

If you’re interested in an unsecured personal loan, visit Rocket Loans to start the loan approval process today.

1Same-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.