What Is an Unsecured Loan and How Does It Work?

An unsecured personal loan lets you borrow a lump sum of money from a lender without any collateral. You’re responsible for repaying the loan over a fixed period, typically through monthly installments.

Here’s how unsecured personal loans work, what rates and requirements to expect and how to decide if it’s right for you.

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MoneyLion offers a service to help you find personal loan offers. Based on the information you provide, you can get matched with offers for up to $100,000 from our top providers. You can compare rates, terms and fees from different lenders and choose the best offer for you.

How Do Unsecured Personal Loans Work?

Unsecured personal loans follow a simple structure with predictable payments and terms:

• Installment structure: You receive a lump sum from the lender. Each month, you’ll repay the loan, including the principal and interest. Typically, the payment amount is fixed, and the term is between 12 and 84 months.

• Fixed repayment schedule: Because the payments are predictable, a fixed repayment schedule can make budgeting easier. Since the loan doesn't require collateral, you don't risk losing a pledged asset directly to the lender if you miss payments.

What Rates Can You Expect?

Interest rates for unsecured personal loans vary based on your credit score, income, DTI ratio and lender. Borrowers with stronger credit generally qualify for lower annual percentage rates (APRs), while those with fair or poor credit may face higher rates and additional fees.

Before applying, compare offers from multiple lenders to see what rates and repayment terms you may qualify for.

Unsecured vs. Secured Loans: What’s the Difference?

The main difference between unsecured and secured loans is whether they require collateral. An unsecured loan doesn’t require collateral, while a secured loan does.

Here’s a side-by-side look at the differences:

Are There Other Types of Unsecured Loans?

Yes. Unsecured personal loans are one type of borrowing that doesn't require collateral. Other options include credit cards, student loans, medical loans and some peer-to-peer (P2P) loans.

Unlike unsecured personal loans, which typically provide a lump sum with fixed monthly payments, credit cards offer revolving credit that you can borrow against as needed. Other unsecured loans may have different eligibility requirements, rates and repayment terms.

What Do You Need To Qualify for an Unsecured Loan?

To qualify for an unsecured loan, you’ll need to meet a few basic requirements.

Eligibility Checklist

• Credit score: Some lenders will accept borrowers with credit scores below 600, but stronger credit generally helps you qualify for lower rates.

• Income verification: You’ll need to provide proof of income in the form of pay stubs or bank statements.

• DTI ratio: Lenders review your DTI ratio to determine whether you can afford another monthly payment. Requirements vary, but a lower DTI generally improves your approval odds.

Documents You’ll Need

• Government-issued ID

• Pay stubs, tax returns and bank statements

• Employment details

• Social Security number

• Bank account information

• List of existing debt and income

Good To Know

Lenders use a simple formula to calculate your DTI ratio:

• Total monthly debt payments ÷ gross monthly income × 100 = DTI percentage

Can a Co-signer Help?

A co-signer agrees to repay the loan if you can't. Keep in mind they’re responsible for payments on the loan, and if a default occurs, it shows up on both your and their credit reports.

How Do You Get an Unsecured Personal Loan?

If you're wondering how to get a personal loan that doesn't require collateral, you can follow these steps:

1. Check your credit score and history: Make sure your credit score is high enough to meet lenders' requirements. If you see any errors on your credit report, reach out to the credit bureaus to dispute them.

2. Compare lenders and prequalify if available: Prequalifying is a great way to get a sense of how much a lender will offer you without a hard credit pull, which occurs after you apply.

3. Gather documents: You'll need a variety of documents to prove you have income when you apply. These include ID, proof of income and employment info.

4. Apply online or in person at a bank or credit union: Online lenders typically approve and fund loans faster than brick-and-mortar locations.

5. Review terms, sign the agreement and receive funds: This could take anywhere from one day to several business days, depending on the lender.

Quick Example: What Does an Unsecured Loan Cost?

Here’s a simple example to give you a general idea of what an unsecured loan might cost.

If you borrow $10,000 at a 12% interest rate over 36 months, you could expect:

• Monthly payment: About $332

• Total interest paid: Around $1,950

Pros and Cons of Unsecured Personal Loans

Unsecured personal loans can be a flexible borrowing option, but they come with both benefits and trade-offs to consider.

What Happens if You Default on an Unsecured Personal Loan?

Defaulting on an unsecured personal loan doesn't mean the lender can automatically seize your home or car, since you haven't pledged an asset as collateral. However, there can still be serious financial consequences.

Here's what could happen if you stop making payments:

• Credit damage: Missed payments can be reported to the credit bureaus and remain on your credit report for up to seven years.

• Collections: Your lender may send the unpaid debt to a collection agency.

• Legal action: The lender or debt collector may sue you to recover what you owe.

• Wage garnishment: If a creditor wins a court judgment, it may be able to garnish your wages, depending on state law.

If you're having trouble making payments, contact your lender to ask about hardship programs or other repayment options before your account becomes delinquent.

Is an Unsecured Personal Loan Right for You?

Whether an unsecured personal loan is right for you depends on your credit score and the purpose of the funds. You need to have a stable income and a repayment plan before you decide to take out a personal loan. Make sure you research lenders before you apply and be on the lookout for potential loan scams.

Good Fit If

• You have a credit score strong enough to qualify for a reasonable rate.

• You like the idea of a fixed payment plan.

• You’re consolidating high-interest debt.

Not Ideal If

• You don't qualify for an affordable APR.

• You're borrowing for a want rather than a need.

• You qualify for a credit card with 0% interest.

• You don’t have a consistent income.

What if You Don’t Qualify? Alternatives To Consider

If you decide an unsecured personal loan isn't right for you or you aren't able to qualify for one, consider one of these alternatives.

• Secured loans: Secured loans are a good option if your credit score isn't high enough to get an unsecured loan. Plus, you may be able to get a lower interest rate in exchange for putting up collateral.

• Home equity line of credit (HELOC): HELOCs are revolving lines of credit you can borrow against, similar to credit cards. They are secured because your home is considered collateral.

• Credit builder loans: With a credit builder loan, you make fixed payments to a lender and get access to the funds after you've made all payments. Since you get the money after paying for the loan in full, there's no risk to the lender. In addition, payment history is reported to the credit bureaus, which can improve your credit score.

If you need a smaller amount quickly, a spot loan may be another option to compare, though rates, fees and repayment terms vary by lender.

Key Terms

• Unsecured personal loan: A fixed-term installment loan that doesn't require collateral. Approval and interest rate are determined by your credit score, income and DTI ratio.

• Collateral: An asset — such as a home or car — a borrower pledges to secure a loan. Unsecured loans don't require it, but secured loans do, and lenders can seize the asset if the borrower defaults.

• APR: The yearly cost of borrowing expressed as a percentage, including interest and certain fees.

• DTI ratio: Your total monthly debt payments divided by your gross monthly income. Lenders generally prefer a DTI below 36% when evaluating personal loan applications.

• Credit score: A numerical measure of your creditworthiness ranging from 300 to 850. Higher scores indicate lower risk to lenders and typically qualify borrowers for better rates and terms.

• Hard inquiry: A credit check a lender initiates when you formally apply for a loan. This check can cause a small, temporary dip in your credit score.

• Origination fee: A one-time upfront charge some lenders deduct from your loan proceeds to cover processing costs; it's part of the total cost of borrowing and varies by lender.

Sources

• CFPB: What Is a Debt-to-Income Ratio?

• CFPB: What Is a Credit Card Interest Rate? What Does APR Mean?

• CFPB: What Happens When a Mortgage Lender Checks My Credit?

• myFICO: What Is a Credit Score?

Sarah Silbert contributed to the reporting for this article.

Photo credit: SDI Productions / Getty Images

Parts of this article were created with AI assistance. MoneyLion editors reviewed, fact-checked and edited the final version and are responsible for its accuracy.