Is an Unsecured Personal Loan Right for You?

The personal loan—and, to be more specific, the unsecured personal loan—has become a very popular way to borrow money. About 22 million Americans had a personal loan as 2022 came to a close, according to a report by Transunion, and many consumers see them as a good choice for a variety of financial needs. 

Let's look at some of the nuances of this useful personal finance option, so you can see if one would suit your needs. 

What is an unsecured personal loan?

The typical personal loan provides a borrower with a set amount (the principal), borrowed for a defined amount of time (the term), and has a fixed interest rate.

Unlike secured loans, such as a home mortgage or vehicle loan, personal loans are usually unsecured, the same as credit cards or student loans. This means you aren't required to pledge any collateral, such as a home or car, as you must with a secured loan. Instead of loaning money based on collateral, the lender gauges their risk by your credit score and credit history.

Most unsecured personal loans share similar factors. For example, TD Bank offers unsecured personal loan options within the typical ranges: Loan terms of 36 to 60 months and loan amounts from $2,000 to $50,000.

Borrowers often decide on what loan terms they would like based on what they want to spend on fixed monthly payments. Longer repayment terms generally offer lower monthly payments, while more repayment time equals more interest that must be paid. Shorter terms may save money overall, but increase the loan payments, so it's a tradeoff.

The loan amount you borrow will depend on your needs. Consider asking for what you really need, and no more. Bigger loans make for larger monthly payments. Don't forget, you must pay interest on that extra principal. If your best loan option ends up including origination fees, find out if it will come out of your loan proceeds in advance. If so, you may need to increase the principal.

Expect the interest rate to vary—it depends on several factors that influence one another. Credit scores play a big part. Good credit typically helps lower your interest rate, and excellent credit may lower it even more. Lenders tend to view lower credit scores as a higher risk.

Oddly enough, the best interest rate you qualify for may not be your best personal loan option. Weird, right? The truth is, there are other factors to think about. Here are some details to watch out for:

  • Origination fee. Some lenders charge 5% or more. This extra amount is either added to your principal in advance or subtracted from your lump sum payout when you receive your loan
  • Application fee. A charge for applying for the loan, whether you are eventually approved or not. Prequalification is sometimes free, regardless of other fees that might be charged
  • Prepayment penalty. You might not worry about this at the start, but prepayment fees could cost a lot if you're suddenly able to pay off your loan early. A hefty prepayment fee can make an early payoff cost more than just making the rest of your equal monthly payments
  • Late fees. If a late payment is made, you can expect to pay a late fee

As an example, TD Bank charges no origination fees, application fees, or prepayment penalties on its personal loan.

The best personal loan for you is the loan that meets all your needs and credit requirements, yet doesn't burden you with extra fees, penalties or unpleasant stipulations. Whether using local banks, credit unions or online lenders, read the fine print carefully. 

What's the best use for an unsecured loan?

Personal loans are typically used for debt consolidation, cars, motorcycles, boats, weddings, medical costs and home improvements. In fact, there are only a few things that you cannot use a personal loan for, including the down payment on a house. Lenders usually will not allow them to be used for college tuition and business expenses, but some do, so it’s worth checking. 

There are other loan options out there to consider. Low-interest, long-term auto loans are sometimes offered by car dealerships to increase the chances you'll buy a car. A home equity loan may be a better choice for funding expensive renovations. If your costs will exceed the offered limits of an unsecured personal loan, a home equity loan may be a good alternative.

What's the difference between secured and unsecured personal loans?

Let's examine some of the pros and cons of unsecured loans.

Pros of unsecured personal loans

  1. The payout of loan proceeds is a lump sum, up front

  2. Funds are provided quickly. The TD Fit Loan, for example, may get you your money in as little as one business day1

  3. The interest rate is usually fixed over the loan's term

  4. They tend to be fixed-rate loans, meaning all loan payments are equal. That makes it easy to budget and keep track of

  5. A home or car isn't used as collateral, so you won't risk losing them

  1. Collateral appraisal isn't required to approve the loan

  2. The minimum loan amount is often lower than other loan types

  3. There's a wide range of loan amounts, terms and interest rates

  4. Some lenders, like TD Bank, offer free prequalification with a "soft credit check" that doesn't affect your credit score

Cons of unsecured personal loans

  1. Interest rates of unsecured loans are generally higher than the best secured personal loans. In secured loans, lenders trust that collateral reduces the chance of default, and that often lowers your interest rate

  2. If your credit score is on the low side, you might not qualify for a loan. With unsecured loans, collateral can't help you qualify. (If your score is very low, bad credit loans might be your best option: Higher interest rate and fees, but easier to qualify) 

  1. Some lenders charge fees—origination, application, prepayment—for unsecured loans. Typically, the lower the applicant’s credit score is, the more likely there will be additional fees

  2. If a loan isn't repaid as agreed, lenders report late payments and defaults to the major credit bureaus. This can really hurt a borrower's credit score. Plus, overdue accounts are often sent to collection agencies

Shop around

No matter what your needs are, there may be a lender out there that can help you. Make sure to account for all fees, different interest rates and other perks a lender might offer. Then apply for the best lending option for you.

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This article is based on information available in June 2023. It is for general informational purposes only. It is not intended to provide specific financial, investment, tax, legal, accounting, or other advice and should not be acted or relied upon without the advice of a professional advisor. A professional advisor will recommend action based on your personal circumstances and the most recent information available. For specific advice about your unique circumstances, consider talking with a qualified professional.

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