What it means
The name comes from the fact that the borrower's signature on the loan agreement is the only security the lender receives. There is no pledge of property, so if the borrower stops paying, the lender must rely on collection efforts and the courts.
For that reason lenders look closely at the borrower's creditworthiness before approving. Typical amounts are modest, ranging from a few hundred to a few tens of thousands of dollars.
They are repaid in fixed monthly instalments over a period of one to five years. Borrowers use them for things like consolidating credit card debt, paying for a medical bill or funding a small business expense.
Because the loan is unsecured, the interest rate reflects the risk. Borrowers with strong credit may get rates close to those on secured loans, while those with weaker credit pay much more.
The rate is usually fixed, so the monthly payment stays the same for the whole term. Compared with a credit card, a signature loan has a set end date and a predictable payment, which helps with budgeting.
Compared with a secured loan, it avoids the risk of losing an asset but costs more in interest. Some lenders charge an origination fee, which is an upfront fee deducted from the amount advanced.
Business owners sometimes use them too, particularly sole traders who cannot offer collateral. In that case the lender may also ask for a personal guarantee.
Anyone comparing offers should look at the annual percentage rate, which combines the interest and fees into a single yearly cost. A missed payment is recorded with credit reference agencies, which makes future borrowing harder and more expensive.
Borrowers who expect difficulty should contact the lender early, since many will agree a revised schedule rather than start collection. Acting before the account falls behind usually leads to better terms.
In practice
Real-world examples.
Example
A teacher with a good credit record borrows $8,000 to replace her boiler. She signs a loan agreement with her bank and offers no collateral. She repays it over three years in fixed monthly instalments, and the lender reports each on-time payment, which slowly improves her credit record.
Example
A graphic designer has $15,000 spread across three credit cards at high rates. He takes a $15,000 signature loan at a lower rate and uses it to clear the cards. His monthly outgoings fall and the debt has a clear end date.
Example
A cafe owner needs $20,000 to buy a new coffee machine and has no property to pledge. Her bank offers a signature loan with a personal guarantee from her. She accepts a higher rate in exchange for not having to pledge her kitchen equipment as security.
Formula
Calculation
Monthly payment = P x r / (1 - (1 + r)^-n), where P is the amount borrowed, r is the monthly interest rate and n is the number of monthly payments
Suppose a borrower takes a $12,000 signature loan at 12% a year for 12 months. The monthly rate is 12% / 12 = 1% = 0.01, so (1.01)^12 = 1.126825 and 1 / 1.126825 = 0.887449. The payment is 12,000 x 0.01 / (1 - 0.887449) = 120 / 0.112551 = about $1,066.19. Over 12 months the borrower repays 1,066.19 x 12 = about $12,794, so the total interest is roughly $794.Case study
Seen in the real world.
Maplewood Print Studio is an illustrative, fictional business run by a single owner who needed $10,000 for a new printer. She had no property to offer as security and her business was only two years old.
The bank agreed to a signature loan at a rate of 14% a year, after reviewing her personal credit record and her last two years of tax returns. Repayments were set over 24 months, and the monthly payment fitted comfortably within her cash flow.
The printer lifted her output by a third, and she repaid the loan early without penalty. The illustrative lesson is that an unsecured loan can be a practical way to fund a small purchase, provided the repayments are affordable and the rate is understood.
Watch out
Common mistakes.
- Comparing only the interest rate, when fees and the annual percentage rate give a truer picture of the cost.
- Borrowing more than the monthly budget can support, since a missed payment damages the credit record.
- Assuming an unsecured loan carries no consequences if unpaid, when lenders can sue, add fees and report defaults.
Questions
People also ask.
Is a signature loan the same as a personal loan?
Largely yes, because both are unsecured and based on credit, although "signature loan" is the older term that stresses the lack of collateral.
What credit score do I need?
Requirements vary by lender, and better credit leads to lower rates, so it helps to check your record before applying.
Can a signature loan be repaid early?
Often yes, but some lenders charge a prepayment fee, so check the agreement before signing.
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