What Is an Unsecured Loan?
How does an unsecured loan work?
Different types of unsecured loans
Unsecured Loan in contrast to. Payday Loan
Special Takes into Account

Personal Finance Credit

Unsecured Loan
By James Chen
Updated February 22 2021
Reviewed by Eric Estevez
Fact checked by Amanda Bellucco and Amanda Chatham
What Is an Unsecured Loan?

An unsecured loan is a loan that doesn't need any type of collateral. Instead of relying on the borrower's possessions as security the lenders are able to approve loans that are unsecured loans based on a borrower's creditworthiness. Examples of unsecured loans comprise personal loans as well as student loans as well as credit cards.
Important Takeaways

An unsecured loan is backed only by the borrower's creditworthiness instead of any collateral such as property or any other asset.
Unsecured loans are riskier as compared to secured loans for lenders, which is why they require higher credit scores for approval.
Credit cards as well as student loans and personal loans are all examples of unsecured loans.
If a borrower fails to pay an unsecured loan the lender could hire a collection agency to collect the debt or take the borrower to court.
Lenders are able to decide whether or not to accept an unsecured loan by assessing the borrower's creditworthiness. However laws protect borrowers from discriminatory lending practices.

How an Unsecured Loan Works

They are also referred to as signature loans or personal loans -- are accepted without the need of property or other assets as collateral. The terms of these loans such as approval and receipt, are most typically contingent on the borrower's credit score. Typically, borrowers must have high credit scores to be approved for non-secured loans.1

A non-secured loan differs from secured loan that is when the borrower pledges a certain kind of asset to be collateral for the loan. The pledged assets boost the loaner's "security" for providing the loan. The most common examples of secure loans include mortgages and car loans.1

Because the unsecured loans require better credit scores than secured loans, in some instances lenders may allow loan applicants with insufficient credit to have a cosigner. A cosigner takes on the legal obligation of settling an obligation if the borrower fails to pay. This happens when a borrower fails to repay the principal and interest payments of a loan or debt.1

Because these loans are not backed by collateral, they're more risky for lenders. This is why these loans typically come with higher interest rates.

If a borrower defaults on a secured loan, the lender can take possession of the collateral in order to recover the losses. However, if a borrower defaults on an unsecured loan, the lender cannot be able to claim any property. However, the lender is able to adopt other measures including directing an agency for collection to collect the debt or taking the borrower to the court. If the court rules in favor of the lender, the borrower's wages could be garnished.1

Additionally, a lien could be put on the home of the borrower (if they own one), or the borrower could be ordered in another way to pay the due amount. In the event of default, it can result in consequences for borrowers, for example, lower credit scores.1
Unsecured Loan
Different types of unsecured loans

Unsecured loans are personal loans and student loans as well as the majority of credit cards. They can all be term or revolving loans.

A revolving loan is a loan that has an amount of credit that can be used, repaid, and spent again. Examples of revolving unsecure loans include credit cards and individual loans.

A term loan, in contrast, is a loan that is repaid by the borrower in equal installments up to the point that the loan is paid off by the expiration of the term. Although these kinds of loans are usually associated with secured loans but there are also unsecured term loans. A consolidation loan used to settle credit card debt , or an individual personal loan from a bank could be considered unsecured loans.1

In recent years, the unsecured loan market has been growing which is largely due to Fintechs (short to mean financial technology firms). The last decade, as an example, has seen the growth of peer-to-peer (P2P) lending through mobile and online lenders.2
$979.6 billion

The amount of U.S. consumer revolving debt as of October 2020, as per the Federal Reserve. 3

If you're looking to take out an unsecured loan to cover personal expenses A personal loan calculator is a great tool to determine what the monthly payment and total interest should be for the amount you're hoping to get.
Unsecured Loan vs. Payday Loan

Alternative lenders, like payday lenders, or businesses which offer cash advances to merchants, do not offer security loans as such. These loans don't have tangible collateral in the manner that auto loans are. However, they take other measures to secure the repayment.

Payday lenders, for example they require that the borrower send them a postdated cheque or agree to an automatic withdrawal from their checking accounts to repay the loan. Some online merchant cash advance lenders require that the borrower to pay a set proportion of online sales using an online payment processor such as PayPal. The loans are considered to be unsecure even though they are partially secured.4

Payday loans can be categorized as precarious loans as they have a reputation for having extremely high rates of interest and hidden terms which charge the borrower additional charges. Some states have prohibited them.4
Special Takes into Account

The lenders have the option of deciding whether or not they will approve an unsecured loan based on your creditworthiness, the law protects consumers from unfair lending practices. The passage of the Equal Credit Opportunity Act (ECOA) in 1974, for example was the first time that it was illegal for lenders to use race, color, sex or religion as non-creditworthiness considerations when evaluating the merits of a loan application, or determining the terms of the loan or in any other aspect of a credit transaction.

Although lending practices have slowly been more equitable in America, there are still some gaps in the system. U.S., discrimination still is a reality. In July 2020 the Consumer Financial Protection Bureau (CFPB) is the agency that oversees compliance and enforces the ECOA, issued an Request for Information soliciting public feedback to determine the best ways of making improvements to the work that the ECOA does to ensure nondiscriminatory ability to access credit. "Clear standards help ensure the protection of African Americans and other minorities however, the CFPB should back them with action to make sure lenders and others adhere to the laws," stated Kathleen L. Kraninger, director of the CFPB.5 6
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Personal Loan Guide to Personal Loans

Personal Loan Types, Definitions, and how to get one
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Understanding Different Loan Types
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Unsecured Loan
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Signature Loan
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What is Peer-toPeer (P2P) lending? Definition and How It Works
5 of 5 of
What is a Payday Loan? What is it, how to Get One, and legality
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Personal Loan Calculator
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Can Personal Loans be tax-deductible?
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Are personal loans considered income?
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Are Personal Loans Included in Bankruptcy?
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Can Personal Loans Be Transferred to a different person?
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How personal loans affect your Credit Score
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What Is an Amortization Schedule? How do you calculate it using Formula
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The Personal Loan Rate of Interest: What to Calculate a Personal Loan is Calculated
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How to apply to get a personal loan
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Best Personal Loans
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Best Small Personal Loans
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Best Bank Loans
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Best Peer-to-Peer Lending
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Personal loans with low interest loans
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The Best Personal Loan Online
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The Best loans for people with bad Credit
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Best loans for fair Credit
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The best personal loans for people with good credit
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The Best Loans for Outstanding Credit
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Best emergency loans for people with bad Credit
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Debt Consolidation Loans for Bad Credit
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Best Consolidation Loans to Condense Debt
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The Best Home Improvement Loans
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The Best Personal Loans with the Co-Signer
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Personal Loans in comparison to. Car Loans What's the difference?
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8 Cheaper Ways to Raise more cash than Car Title Loans
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Related Terms
Signature Loan
A signature loan is a personal loan that banks and other finance companies that relies only on the signature of the borrower and guarantee to pay the loan as collateral.
more
The meaning of default What happens when you Involve in a default, Examples
A default happens when a person who is borrowing fails to make the necessary payments on a debt, whether of interest or principal.
More
Collateral Definition, Types, & Examples
Collateral is an asset is accepted by a lender as security to extend an loan. If the borrower defaults the lender can take possession of the collateral.
more
What is a Payday Loan? What is it, how to Get One, and Legality
The term payday loan is a type of borrowing that's short-term and where a lender can extend credit with high interest according to your income.
More
What is a creditor? and what happens if they Aren't Repaid?
A creditor extends credit to another party to borrow money usually by an agreement known as a loan deal or contract.
more
Non-Recourse Debt: Definition, Example, vs. Recourse Debt
A non-recourse debt is a type of loan that is secured by collateral, typically property, and the lender is at greater risk in the event that the borrower fails to pay on the loan.
more
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