how an unsecured loan works
unsecured loans sometimes referred to as signature loans or personal loans are approved without the use of property or other assets as collateral the terms of these loans including approval and receipt are most often contingent on a borrower s credit score typically borrowers must have high credit scores to be approved for unsecured loans an unsecured loan stands in contrast to a secured loan in which a borrower pledges some type of asset as collateral for the loan the pledged assets increase the lender s security for providing the loan examples of secured loans include mortgages and car loans because unsecured loans require higher credit scores than secured loans in some instances lenders will allow loan applicants with insufficient credit to provide a co signer a co signer takes on the legal obligation to fulfill a debt if the borrower defaults this occurs when a borrower fails to repay the interest and principal payments of a loan or debt because unsecured loans are not backed by collateral they are riskier for lenders as a result these loans typically come with higher interest rates if a borrower defaults on a secured loan the lender can repossess the collateral to recoup the losses in contrast if a borrower defaults on an unsecured loan the lender cannot claim any property but the lender can take other actions such as commissioning a collection agency to collect the debt or taking the borrower to court if the court rules in the lender s favor the borrower s wages may be garnished also a lien can be placed on the borrower s home if they own one or the borrower may be otherwise ordered to pay the debt defaults can have consequences for borrowers such as lower credit scores types of unsecured loansunsecured loans include personal loans student loans and most credit cards all of which can be revolving or term loans a revolving loan is a loan that has a credit limit that can be spent repaid and spent again examples of revolving unsecured loans include credit cards and personal lines of credit a term loan in contrast is a loan that the borrower repays in equal installments until the loan is paid off at the end of its term while these types of loans are often affiliated with secured loans there are also unsecured term loans a consolidation loan to pay off credit card debt or a signature loan from a bank would also be considered unsecured term loans in recent years the unsecured loan market has experienced growth powered partly by financial technology fintech firms the past decade for example has seen the rise of peer to peer p2p lending via online and mobile lenders the amount of u s consumer revolving debt in oct 2023 according to the federal reserve if you re looking to take out an unsecured loan to pay for personal expenses a personal loan calculator is an excellent tool for determining what the monthly payment and total interest should be for the amount you re hoping to borrow unsecured loan vs payday loanalternative lenders such as payday lenders or companies that offer merchant cash advances do not offer secured loans in the traditional sense their loans are not secured by tangible collateral in the way that mortgages and car loans are however these lenders take other measures to secure repayment payday lenders for example require that borrowers give them a postdated check or agree to an automatic withdrawal from their checking accounts to repay the loan many online merchant cash advance lenders require the borrower to pay a certain percentage of online sales through a payment processing service such as paypal these loans are considered unsecured even though they are partially secured payday loans may be considered predatory loans as they have a reputation for extremely high interest and hidden terms that charge borrowers added fees in fact some states have banned them special considerationswhile lenders can decide whether or not to approve an unsecured loan based on your creditworthiness laws protect borrowers from discriminatory lending practices the enactment of the equal credit opportunity act ecoa in 1974 for example made it illegal for lenders to use race color sex religion or other non creditworthiness factors when evaluating a loan application establishing terms of a loan or any other aspect of a credit transaction while lending practices have gradually become more equitable in the united states discrimination still occurs in july 2020 the consumer financial protection bureau cfpb which takes the lead in supervising compliance and enforcing the ecoa issued a request for information soliciting public comments to identify opportunities for improving what the ecoa does to ensure nondiscriminatory access to credit clear standards help protect african americans and other minorities but the cfpb must back them up with action to make sure lenders and others follow the law stated kathleen l kraninger then director of the cfpb 