When people look for the right loan to fit their financial needs, one of the options they’re sure to come across is a personal loan, either secured or unsecured. Among the most common uses for personal loans are paying off credit card balances to save on interest costs, funding home renovations, and debt consolidation.
Unsecured personal loans may provide an opportunity to borrow for those who cannot or do not want to use collateral to obtain a loan. However, there’s more to unsecured personal loans than just the collateral factor.
How do you know if an unsecured personal loan is the right choice for you? We’ll dive into exactly what an unsecured personal loan is, the benefits of an unsecured personal loan, and how to choose the best loan for your situation.
What Is an Unsecured Loan?
An unsecured loan is a loan that is not backed by collateral. Compare this to a secured loan, which is backed by an asset such as your home, bank account balances, or vehicle, for example. To have a loan “backed” by an asset means that a bank or lender has the right to take that asset in the event of default on the loan.
Loans backed by collateral are generally considered by banks to be less risky because if the borrower defaults on the loan, they are able to recoup the balance due by seizing the collateralized property.
When loans are viewed as less risky by lenders, they tend to have low interest rates, if everything else is equal. Lenders will also generally approve greater loan amounts when a loan is backed by an asset of value than when it is not.
Unsecured loans, on the other hand, are not backed by collateral. Therefore, they are likely to have higher interest rates and lower loan amounts than secured loans.
What Are Common Uses for Unsecured Personal Loans?
Here are a few of the most common uses for an unsecured personal loan:
Credit Card Payoff
Credit cards tend to have high annual percentage rates (APRs). Currently, the average credit card interest rate is just over 16% . A credit card interest calculator can give you an estimate of how much total interest you’ll pay on the remaining balance and when you’re likely to pay off that balance, given your interest rate and monthly payment.
Some borrowers may use an unsecured personal loan to pay the balance of their credit card debt. Repaying debt with a personal loan that has a lower interest rate than they were paying on their credit card could mean substantial savings on sizable credit card balances. Using a personal loan calculator can give you an estimate of potential savings if you’re thinking of using an unsecured personal loan to pay off a credit card balance.
Debt Consolidation
Debt consolidation is the process of taking out one new loan to pay off multiple debts. The borrower could potentially save money over the life of the loan if the consolidation loan has a lower interest rate than the old loans had. If the borrower makes larger payments over a shorter term length, they could also potentially save money over the life of the loan. This strategy also could be helpful for anyone who does not want to manage multiple payments each month.
Medical Expenses
Medical expenses can put a person in a tough financial situation. Medical bills can sometimes be negotiated and/or payment plans put into place. If these options don’t provide a reasonable path toward paying for past medical services, some borrowers may opt to take out a personal medical loan to cover any remaining balance.
Home Projects
Whether it’s something big like adding a bedroom to a home or something small like replacing kitchen fixtures, homeowners might consider an unsecured personal loan, also called a home improvement loan, to obtain funding for a home project.
This could be especially useful for someone who needs cash for immediate repairs or emergencies. An unsecured personal loan can be an alternative to taking out a home equity loan or home equity line of credit for remodeling or repairs, both of which are secured loans and require equity in your home.
What Are Some Different Types of Unsecured Loans?
Many personal loans are unsecured loans. They are installment loans, paid back over a set term on a regular payment schedule with either a fixed or variable interest rate.
Federal student loans are another type of unsecured loan, and come with their own unique requirements, protections, repayment options, grace periods, and federal regulatory requirements that must be met.
A credit card is also a type of unsecured loan. Essentially, when you’re approved for a credit card, you’re being approved for a revolving line of credit. Instead of a lump sum loan, it’s a loan where you’re basically borrowing what you need when you need it — and you can borrow again and again as long as you pay it back.
Why Choose an Unsecured Personal Loan?
Ultimately, every borrower must decide what makes the most sense for themselves and their financial situation when making the secured versus unsecured loan decision. There are some common reasons for choosing an unsecured loan, though.
• Processing ease and time. A lender will likely require fewer pieces of documentation for an unsecured personal loan than its secured counterpart. Why? With a secured loan, the lender needs to provide proof of the value of the collateral — and that can take time.
• Consistent payments. When consolidating debt, using an unsecured personal loan that has a fixed interest rate and a specific end date may make getting out of debt an attainable financial goal.
• Potentially low interest rates. The interest rate a loan applicant is approved for will depend on a variety of factors, but an unsecured personal loan’s interest rate will likely be lower than many credit card interest rates.
• Flexibility. An unsecured personal loan can be used for a variety of purposes. There are some restrictions, though, so it’s important to check with the lender to make sure you’re using the funds properly.
• No collateral. An unsecured personal loan does not require collateral to be put up as a loan guarantee. Some people may not want to risk an asset when seeking financing.
Applying for an Unsecured Personal Loan
First, and as with any financial commitment, make sure your finances are in order. Checking your credit report regularly is a good way to catch any possible errors and correct them, minimizing any negative affect on your credit score.
Unsecured personal loans typically require a higher level of creditworthiness than a secured personal loan does. If you’re planning to apply for an unsecured personal loan in the future, you can start by doing things like making timely credit card payments to help responsibly build up your credit.
Recommended: How to Pay Tax on Personal Loans
If you have a weaker credit score, however, all is not lost. Many lenders will consider loaning money to borrowers with a weaker credit score or not enough credit history if they have a cosigner or coborrower with a more favorable credit history, consistent income, and other positive financial attributes.
Next, find a reputable lender that offers unsecured personal loans. Some things to look for include potential interest rates you might qualify for, terms that work for you, and any extra fees (origination fees or prepayment penalties, for example) so that you understand the true cost of the loan.
The Takeaway
For some of life’s many curveballs — or opportunities — the occasional need for an unsecured personal loan might arise. With no fees and competitive fixed rates, a SoFi Personal Loan may be the right option for your financial needs.
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC), and by SoFi Lending Corp. NMLS #1121636 , a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law (License # 6054612) and by other states. For additional product-specific legal and licensing information, see SoFi.com/legal.
Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.
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