How An Unsecured Personal Loan Works

An unsecured personal loan can be a great option when you need money quickly.

But, there’s a lot more to know about them before you go ahead and submit that application.

What’s the credit requirement on an unsecured personal loan? Are there any hidden fees? What documentation will you need to complete the process?

These are just a few of the questions that you might have.

But, we’re going to go over this and more.

We’re going to cover:

What Does Unsecured Personal Loan Mean?

An unsecured personal loan means the money given to the borrower is not backed by any collateral, property, or down payment. The approval will be based on the borrower’s credit score and history, as well as their debt to income ratio.

Without proper collateral, there is no way for the lender to recoup their money if you were to cease payments. This is why your credit score will be a determining factor for your approval.

How Do Unsecured Personal Loans Work?

Personal loans work by giving you access to money for various expenses. Once the loan is issued, you will end up paying the money back over a set period of time, with interest and fees.

You can request an unsecured personal loan for almost any personal expense, and there’s a million different reasons why you might apply for a loan.

Among the many reasons to apply for an unsecured personal loan, here are some common ones:

Help you pay for a home repairs or improvements
Pay for a wedding
Pay off debt
Help improve your credit
Create an emergency fund
Purchase or repair of a vehicle
Down payment on a property
Cover a college tuition
Travel costs

Beware: Some lenders won’t approve an unsecured personal loan for business purposes, or even secondary education in some cases.

Is An Unsecured Loan Right For You?

Unsecured personal loans are a great option, but they aren’t the best choice for everyone.

Why?

Qualifying for one of these loans can be tricky. And even once you qualify, it’s comparatively an expensive financial move when you consider all the other options.

However, it might be the best choice for people in certain situations. So let’s go over those:

People that need money fast: Some people may own homes with substantial equity, but tapping into it could take weeks to even get approved. Applying for a personal loan is easier and faster than waiting.
People who have their savings tied up in retirement accounts: If you aren’t at the age where you can access your retirement funds without any penalties, applying for a personal loan will give you access to money that won’t be as expensive.
People who don’t own a home or don’t have equity to borrow against: Not everyone owns a house to borrow against, but may still need money quick. Personal loans are a great way to accomplish what you need.

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What Are Unsecured Personal Loans Based On

In order to qualify for an unsecured personal loan, you’ll need to pass a credit check before the loan gets sent to underwriting. Here’s what they’ll consider when your loan is in underwriting:

Minimum Credit Score: Should be around 640-750
Income Verification: Your income will be verified in order to ensure that you make a salary that will sustain the loan amount. The underwriter will want to make sure that your debt to income ratio does not exceed 43%.
Interest Rate: The interest rate will be around 8.50% to 18% depending on your credit score. Remember that the lower your credit score is, the closer you’ll be to that 36% APR.
Work History: Lenders will look at the number of years you’ve been employed. They want to make sure that you have a stable job which can support the loan payments.
Residency: The lender will verify that you are a US citizen, permanent resident, or on a long term visa. They will also take into account how long you’ve lived at your current location. Be prepared to provide information on your residences for the last 2 years.
Age: In most states, you need to be 18 years old in order to apply for a loan. However, some states require you to be 19 or even 21 in order to take out a loan. So, be sure to look into the requirements in your specific state.

What Credit Score Is Needed For a Personal Loan?

The higher your credit score is, the lower your the interest rate will be.

The average requirement when it comes to credit score is to have a Good to Excellent rating, but some lenders will approve you with a score in the Fair range.

Here’s a breakdown of the FICO Score ranges:

780 – 850: Excellent
720 – 780: Good
640 – 720: Fair
580 – 640: Poor
300 – 580: Very Poor

When applying for an unsecured personal loan, take the time to verify your credit score first. This will allow you to know if there is the possibility of an approval right now.

If your credit score disqualifies you from qualifying right now:

Take the time to improve your credit score before you apply
Look into options for personal loans with bad credit

Having bad credit can make it challenging to get approved for a loan, but not impossible. Be prepared to deal with things like higher interest rates and fewer options.

In some cases, getting a small secured loan can be a great starting point.

Unsecured Personal Loan Rates

When it comes to getting an unsecured personal loan, rates and fees will vary based on many different factors.

This type of loan usually has a short term, averaging anywhere from 1 – 7 years. However, the most common unsecured personal loan term is 5 years.

So what should you be on the lookout for when you start researching personal loan options?

Interest rate: Rates typically range from 5 to 36%, and will vary by lender. Your credit score will have a large impact on your interest rate. Keep in mind that the longer the term of the loan, the more interest you will end up paying.
- Fixed interest rate: Your interest rate won’t change over the life of the loan
- Variable interest rate: Your interest rate may change depending on the market.
Origination fees: These fees will range from 1% to 6% of the loan amount and will cover the processing cost of the loan. Not all lenders will require you to pay an origination fee.
Prepayment fee: This does not apply to all lenders, but some will charge a fee if you pay the loan off before the agreed upon term. Paying your loan off early means your lender will miss out on some of that interest. So, they compensate themselves by charging you a prepayment penalty.
Late fees: Late payments could vary anywhere from $10 to $50 per missed payment.

Where to Get Unsecured Personal Loan

You can apply for unsecured personal loans in banks, credit unions and with online lenders. It’s going to come down to your preferences.

If applying with a bank: You can complete the process online, over the phone, or by visiting a branch.
If applying with a credit union: You can complete the application online, in a branch, or over the phone. However, in order to borrow money from a credit union, you must be a member with an open account. In some cases, there may even be a balance minimum that you must keep on that account. Credit unions may have less strict lending requirements, and they typically offer lower interest rates.
If applying with an online lender: The entire loan process will be handled online when you select an online lender. Be sure to check if the company you have selected operates in your state. Some online lenders have restrictions on which states they can issue loans in.

Unsecured Personal Loan Advantages and Disadvantages

Advantages

1. No Risk for your Personal Property or House

An unsecured loan means no risk of losing your home, even if you default on the loan. You won’t have to worry about your house being on the line because you lost your job or got sick and couldn’t afford the payments.

2. Quick and Convenient Process

The process for applying for an unsecured loan is quicker than a secured one because there aren’t any titles or collateral to be evaluated for an approval. Often times, these loans don’t have high loan limits, so it’s possible to receive the money the same day you are approved.

Disadvantages

1. Payments and Rates are Higher

Since this type of loan is riskier than a secured loan backed up by collateral, lenders usually charge higher interest rates. The more you are a risk to the lender, the more you’ll end up paying. Basically, the lower your credit score is means the higher of a risk you are to the lender. So evidently, the higher your interest rate will be.

Beware: Some lenders will attempt to hide their high interest rates by presenting it to you as a loan origination fee, or even an application fee.

2. Limited Loan Amounts

If you are in the need of a substantial amount of money, an unsecured loan will probably not be the right choice for you as the lending limit is $25,000.

3. No Flexibility or Changes

When you get an unsecured loan you are agreeing to pay the money back over a specific term with a specific payment amount. You will not have the ability to adjust the loan terms later on. Plus, you might be hit with a prepayment penalty fee if you pay the loan off sooner than agreed upon.

How To Apply For An Unsecured Loan

To make it easy for you, we are going to walk you through the steps you’ll need to take in order to apply for an unsecured loan.

Step 1

First, you are going to compare your options among different lenders.

You’ll want to:

Verify the minimum and the maximum loan amount the lender will allow you to apply for.
Confirm the minimum and the maximum loan terms offered by the lender.
Verify what type of fees are attached to applying for a loan with each lender. Double check if there are any origination fees, prepayment fees, late fees, and the cost of each.
Compare the interest rate of the loan with the other lenders you’re looking into. Make sure you know whether the interest rate is fixed or variable.

Once you have gathered all of the information above, you should put it through a loan repayment calculator to see what your monthly payment would be. Make sure the monthly payment is something you won’t have a problem affording.

If you’re not sure if you can afford the monthly payment or not, you should take the time to create a budget which will help you determine whether this payment fits within your allowance.

Step 2

Next, you’ll want to verify the requirements to get approved for the loan. You’ll want to do this before applying for the loan, so you can avoid lowering your credit score with a hard inquiry if you find out your score isn’t up to par.

Factors lenders will look at:

Your credit score
Years of employment
Income
Residency
Age

Keep in mind that in some cases, even if you meet all of the requirements, your loan might still not get approved.

Step 3

It’s time to complete the application and apply for the loan!

Apply for the loan by:

Phone
Visiting a local branch
Online

Once this is done, you will need to send certain documentation for the loan to get completely processed. In most cases loans, your loan will get pre-approved contingent on receiving the proper documentation to support the information in your application.

Some of the documents required:

Primary ID – You can provide:
- Driver’s license
- Passport
- Any other legal government identification
Proof of your Income – Usually they require a month’s worth of pay stubs.
Social Security Number – Need to provide the social security number for them to be able to confirm your identity.

Step 4

Approval time!

Usually, you’ll get a response within minutes of applying for an unsecured loan. In some cases, it could take up to a couple of days.

Typically, your loan will be pre-approved and put in a conditional approval until all of the required documentation is received and verified. Once this is complete, you’ll receive a full approval. This is when you’ll sign all of your loan agreement documents.

Step 5

Now it’s time for the disbursement of the loan.

This is when you’ll receive the money from the lender. You can either select to receive the money via a direct deposit to an existing account, or by a check via mail if applying in person.

Step 6

Lastly comes the repayment.

At this time you’re going to need to make the decision of whether you’ll manually make your monthly payments, or if you’d like to sign up for automatic debits out of your account.

No matter which route you take, make sure your payments are on time.

Establishing a budget and sticking to it isn’t easy, but it’s the best way to be in control of your finances! 💪

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Conclusion

Personal loans can be used for a wide variety of expenses. Make sure that you borrow when you really have a reasonable purpose to do so as these loans tend to be more expensive than traditional lending methods.

Don’t get carried away with debt to the point that you find yourself struggling to get out of it.

Do you think an unsecured personal loan is the right option for you? Let us know in the comments!

Up Next: How To Get A Personal Loan With Bad Credit