What Is an Unsecured Loan?
An unsecured loan is a loan that doesn’t require any type of collateral. Instead of relying on a borrower’s assets as security, lenders approve unsecured loans based on a borrower’s creditworthiness. Examples of unsecured loans include personal loans, student loans, and credit cards.
- An unsecured loan is supported only by the borrower’s creditworthiness, rather than by any collateral, such as property or other assets.
- Unsecured loans are riskier than secured loans for lenders, so they require higher credit scores for approval.
- Credit cards, student loans, and personal loans are examples of unsecured loans.
- If a borrower defaults on an unsecured loan, the lender may commission a collection agency to collect the debt or take the borrower to court.
- Lenders can decide whether or not to approve an unsecured loan based on a borrower’s creditworthiness, but laws protect borrowers from discriminatory lending practices.
How an Unsecured Loan Works
Unsecured loans—sometimes referred to as signature loans or personal loans—are approved without the use of property or other assets as collateral. The terms of these loans, including approval and receipt, are most often contingent on a borrower’s credit score. Typically, borrowers must have high credit scores to be approved for unsecured loans.
An unsecured loan stands in contrast to a secured loan, in which a borrower pledges some type of asset as collateral for the loan. The pledged assets increase the lender’s “security” for providing the loan. Examples of secured loans include mortgages and car loans.
Because unsecured loans require higher credit scores than secured loans, in some instances lenders will allow loan applicants with insufficient credit to provide a cosigner. A cosigner takes on the legal obligation to fulfill a debt if the borrower defaults. This occurs when a borrower fails to repay the interest and principal payments of a loan or debt.
Because unsecured loans are not backed by collateral, they are riskier for lenders. As a result, these loans typically come with higher interest rates.
If a borrower defaults on a secured loan, the lender can repossess the collateral to recoup the losses. In contrast, if a borrower defaults on an unsecured loan, the lender cannot claim any property. But the lender can take other actions, such as commissioning a collection agency to collect the debt or taking the borrower to court. If the court rules in the lender’s favor, the borrower’s wages may be garnished.
Also, a lien can be placed on the borrower’s home (if they own one), or the borrower may be otherwise ordered to pay the debt. Defaults can have consequences for borrowers, such as lower credit scores.
