One type of unsecured term loan is the signature loan. It does not require collateral and bad credit ok with your signature. This represents their “good faith” promise that they will repay the loan.
You can be hit hard by unexpected bills. You might have to pay for a major home or medical repair, or you may need to be treated for an emergency. You may also have high-interest debt that you want to consolidate into one loan. Signature loans, a type of unsecured loan, can be an option in either of these cases. This article will provide an overview of the pros and cons of signing loans.
Secured vs. Unsecured Loans
Secured loans have some type of collateral to support – or secure it. A mortgage is a form of collateral that the home serves as. If you default on your mortgage payments, the bank may seize your home to pay off your loan balance.
An unsecured loan has no collateral to support the loan balance. This means that the only collateral you can provide is your signature and promise of repayment. Signature loans are also known as “good faith loans” and “character loans” because the only collateral you provide is your signature and promise to repay it.
Revolving Credit vs. Term loans
Signature loans, which are not revolving credit, are the next type of term Loan. Revolving credit limits the amount that you can borrow. A HELOC could provide $25,000 of revolving credit. You only pay interest when you borrow money against your HELOC. You can once more access the credit amount when you repay it.
Term loans, on the other hand, provide a set amount of loan and a repayment period (i.e. loan terms. You’ll be paid a lump sum at the start of your loan period with the total signature loan balance. Each month, you will pay the same amount to the lender with a portion going to loan principal and another portion going to interest. You’ll be paying more interest each month at the beginning of your repayment period. You’ll pay more principal towards the end.
After you have repaid the entire signature loan amount, your loan account is closed and you are no longer eligible for credit. If you need additional funds, you will need to apply to another signature loan.
Qualifying for a Signature Loan
Signature loans are not available to everyone because of their unsecure nature. Signature loans are not available to everyone. Borrowers must demonstrate that they can repay the loan amount. To qualify for a signature loan, borrowers must meet these criteria:
- History and strong credit rating
- Stable employment
- You have enough income to pay your monthly principal and interest payments.
While each lender has its own requirements for signature loans, borrowers can expect to see some variations of these criteria. A lender might still approve your signature loan application if you have a poor financial history. However, you can expect a higher interest-rate and a lower maximum loan amount.
Common Situations Where Signature Loans Are Used
Consolidate Credit Card Debt
Signature loans are more expensive than mortgages, home equity loans and HELOCs but they have lower interest rates than credit cards. Many borrowers opt to consolidate their debt with one signature loan.
Let’s say you have three credit card accounts with $20,000 in outstanding balances and an average interest rate of 22%. You could get a $20,000 signature loan at 10% and use the proceeds to pay off all your credit card debts. This will save you a lot of interest and simplify your repayments as you only have to make one monthly payment.
Signature loans are sometimes used by homeowners to fund home improvements. HELOCs and home equity loans offer lower rates but not all homeowners have enough equity to be eligible for these products. Signature loans are a great way to finance major home repairs or improvements.
In an ideal world, insurance would cover every medical emergency. It would be foolish to think so, since medical emergencies can run into the thousands of dollars, even with insurance. Signature loans are often used to pay for large medical bills when there is not enough cash. This allows you avoid high credit card interest rates and still repay the loan over time.
Signature Loans: Pros and Cons
Pros of Signature loans
Traditional credit applications can be delayed by lenders who review the application. These reviews are still required for signature loans, but they are usually faster. Signature loan funds are then deposited directly to your bank account once they have been approved. This allows for a much faster time from the application to the availability of funds.
Lump sum Access to Funds
Certain businesses and organizations won’t accept credit cards to pay a bill. Borrowers will need to pay cash instead. A signature loan allows you to receive all of the loan amount in cash. This allows you to pay cash-only bills without financing.
Signature loans allow for flexible repayment terms. You can request loan terms ranging from 3 months to 15 years depending on your individual situation. Some lenders may allow you to extend the term for up to 15 years. Although longer repayment terms typically result in higher interest payments and lower monthly payments, borrowers can still get the flexibility they need.
Cons of Signature loans
Higher Interest rates
Signature loans offer lower interest rates than credit card in many cases. These loans will also have higher interest rates that secured loans. A $25,000 HELOC, which is secured by your home equity, will have a lower interest rate than a signature mortgage for the same amount. This is even with excellent credit ratings. Lenders are more likely to take on risk if there is no collateral. Higher rates can help offset this risk.
Signature loans can have very high fees. Borrowers should carefully read the terms and conditions before applying. Origination fees, which are charged by many lenders, can be very high. A lender might charge a 2% origination cost based on the loan amount. For a $10,000 loan, this would amount to $200. This means that you will only get $9,800 in cash ($10,000 loan + $200 origination fee).
Many signature loans will also have prepayment and late payments penalties. These fees can vary from lender to lender so be sure to understand them when you apply.
Lesser Loan Amounts
Signature loans are more risky than secured loans because they lack collateral. Auto and home loans. Signature loans are subject to lower loan limits than other lenders. Although each lender may have its own limit, many lenders won’t approve signature loans exceeding $50,000. Experian, a credit reporting agency, says that signature loans typically range from $3,000 to $50,000 with the average loan at the lower end.
Signature loans are a viable financing option for some borrowers. Consolidating high-interest credit card debt into one, lower-interest signature loan is a great way to save money, especially if you have high interest debt. These loans shouldn’t be used to replace an emergency fund.