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

Personal Finance Credit

Unsecured Loan
By James Chen
Updated February 22 2021
Read by Eric Estevez
Fact checked by Amanda Bellucco and Amanda Chatham
What is an unsecured loan?

An unsecured loan is an unsecure loan which doesn't require any kind of collateral. Instead of relying on the collateral source lenders will approve loans that are unsecured loans by assessing the borrower's creditworthiness. Examples of non-secured loans are personal loans, student loans, and credit cards.
Key Takeaways

An unsecured loan is backed only by the borrower's creditworthiness, rather than by any collateral like the property and other property.
Unsecured loans are riskier in comparison to secured loans for lenders, and they require higher credit scores for approval.
Credit cards as well as student loans as well as personal loans are all examples of unsecure loans.
If a borrower defaults on an unsecure loan, the lender may commission a collection agency to recover the debt or go to court.
Lenders can decide whether or not to approve an unsecured loan by assessing the borrower's creditworthiness. However laws safeguard borrowers from unfair lending practices.

How does an unsecured loan work?

These loans, sometimes referred to"signature loans or personal loans--are granted without the need for property or other assets to serve as collateral. The terms of these loans, including approval and receipt, are typically contingent on the person's credit rating. Typically, borrowers need to have a high credit score in order to be eligible for unsecured loans.1

An unsecured loan stands in contrast to a secured loan that is when the borrower pledges a certain kind of asset to secure the loan. The pledged assets increase the lender's "security" in providing the loan. Some examples of secured loans include car loans.1

Since unsecured loans require higher credit scores than secured loans, in some instances lenders may allow loan applicants who have poor credit to provide a cosigner. A cosigner assumes the legal obligation to fulfill an obligation if the borrower fails to pay. The situation occurs when a person is unable to pay principal and interest of the loan or debt.1

Because unsecured loans aren't backed by collateral, they're riskier for lenders. In turn, these loans generally carry 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. If, however, the borrower defaults on an unsecured loan and the lender does not be able to claim any property. However, the lender is able to adopt other measures including directing a collection agency to collect the debt , or going to court. If the court rules in the lender's favor, the borrower's salary could be garnished.1

A lien may also be put on the home of the borrower (if they have one) or the borrower might be ordered to pay off the due amount. The consequences of defaults for the borrower, including less credit scores.1
Unsecured Loan
Different types of unsecured loans

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

A revolving loan is a loan with an amount of credit that can be used to pay back, spent, and spent again. Examples of revolving unsecure loans include credit cards and private loans.

A term loan, in contrast, is a loan that the borrower repays by equal monthly installments, till it is loan is paid off when it has reached the conclusion of its period. While these types of loans are typically associated with secured loans but there are also unsecure term loans. For example, a Consolidation loan to pay off credit card debts or the personal loan from a bank would be considered unsecured loans.1

In recent years, the unsecured loan market has experienced growth driven by the fintechs (short to mean financial technology firms). The past decade, for example, has seen the growth of peer-to peer (P2P) lending through mobile and online lenders.2
$979.6 billion

Amount of U.S. consumer revolving debt at the time of October 10, 2020 in accordance with the Federal Reserve. 3

If you're considering taking out an unsecure loan to pay for your personal expenses such as a car, a personal loan calculator is an ideal tool to figure out the monthly amount and total interest should have to be in relation to what you're planning to borrow.
Unsecured Loan vs. Payday Loan

Alternative lenders, such as payday lenders, or businesses that provide merchant cash advances do not provide security loans in the traditional sense. They're loans are not secured by tangible collateral, the way that mortgages and automobile loans are. However, these lenders take other measures to secure their repayment.

Payday lenders, for instance will require that customers give them a postdated check or agree to the automatic withdrawal of their checking accounts to pay the loan. Some online merchant cash advance lenders require that the borrower to pay a set percentage of online sales through a payment processing service such as PayPal. These loans are considered unsecured even though they are partially secured.4

Payday loans may be considered precarious loans due to their reputation for having extremely high rates of interest and hidden terms that cost borrowers additional fees. In fact, some states have banned them.4
Special Beacons

The lenders have the option of deciding whether or not they will approve an unsecured loan in accordance with your creditworthiness, laws protect the borrowers from lending practices that discriminate against them. The passing of the Equal Credit Opportunity Act (ECOA) in 1974, for example was the first time that it was unlawful for lenders to consider race or color, gender or religion as non-creditworthiness considerations when evaluating a loan application, establishing terms of a loan or any other aspect of a credit transaction.

While lending practices have gradually improved in the U.S., discrimination still exists. In July 2020 the Consumer Financial Protection Bureau (CFPB), which takes the lead in supervising compliance and enforcement of the ECOA issued an Request for Information soliciting public comments to identify opportunities for improving the work that the ECOA is doing to ensure that there is no discrimination in accessibility to financial services. "Clear guidelines help ensure the protection of African Americans and other minorities, but the CFPB must support them with actions to ensure lenders and others follow the law," stated Kathleen L. Kraninger Director of the CFPB.5 6
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Personal Loan Guide to Personal Loans

Personal Loan: Definition, Types, 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-to-Peer (P2P) Lending? What is its definition and how it works
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What is a payday loan? How Does It Work, How to Get One and the Legality
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Personal Loan Calculator
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Are Personal Loans 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 another person?
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What effect do personal loans have on your Credit Score
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What is an Amortization Schedule? How do you calculate it using Formula
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Personal Loan Interest Rates: The Way a Personal Loan Is Calculated
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How to apply for a Personal Loan
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Best Personal Loans
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The Best Small Personal Loans
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Best Bank Loans
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Best Peer-to-Peer Lending
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low-interest personal loans
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Best Online Personal Loans
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The Best Credit Loans for 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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Best emergency loans for bad Credit
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Credit 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 vs. Credit Cards What's the Difference?
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Personal Loans vs. Car Loans: What's the Difference?
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8 Ways to raise more cash than Car Title Loans
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Related Terms
Signature Loan
Signature loan is a type of personal loan provided by finance companies and banks that relies only on the borrower's signature and commitment to pay collateral.
more
The meaning of default, What Happens When You Default, Examples
A default occurs when a person who is borrowing fails to pay the required amount on a debt, whether of principal or interest.
More
Collateral Definition, Types, & Examples
Collateral is an asset a lender accepts as security in order to extend an loan. If the borrower defaults the lender can seize the collateral.
More
What Is a Payday Loan? How It Works, How to get One and the Legality
A payday loan is a type of short-term borrowing where a lender will provide high-interest credit dependent on your income.
more
What is a Creditor? and What Happens If Creditors aren't paid?
A creditor gives credit to another person to obtain money typically through an agreement known as a loan deal or contract.
more
Non-Recourse Debt: Definition, Example, vs. Recourse Debt
A non-recourse loan is a type of loan that is secured by collateral, typically property, and the lender assumes a greater risk if the borrower defaults with the loan.
More
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