Signature Loan

It is used as a promise to pay the loan back when it is time

Author: Nikaila Alim
Nikaila Alim
Nikaila Alim
I am a recent graduate from Hunter College
Reviewed By: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Last Updated:November 27, 2023

What is a Signature Loan?

A Signature Loan is a type of unsecured personal loan. It is also known as a “good faith loan” or a “character loan.” Financial institutions like banks offer these loans and only require the borrower's signature. The signature is used as a promise to pay the loan back when it is time.

This can be used for anything; however, due to the loan being unsecured, the interest rate for these loans is typically higher than secured loans. 

These unsecured loans are charged a fixed monthly rate over time. 

What is an unsecured loan? Unsecured loans are loans that do not require any kind of physical collateral. In this case, a signature is all that is needed after meeting the lender’s requirements. 

The higher interest rates for these loans are simply because the lender is taking on more of a risk when a loan is not supported by collateral. 

There are many types of unsecured loans. The popular unsecured loans are credit cards, student loans, and personal loans. 

A few pros to unsecured loans are fewer borrowing restrictions, no collateral, and borrowers typically gaining access to quick funds. 

A few cons to unsecured loans are that they are harder to approve, and borrowers with low credit scores might have low borrowing limits and higher interest rates. 

On the other hand, secured loans always require collateral. A few secured loans are car loans, home loans like mortgages, and some personal loans. 

Understanding a Signature Loan

In order to grant a signature loan, lenders look for borrowers with a good credit history as well as a good income source to repay the loan. In some cases, the lender may require a cosigner who is only needed if the original lender defaults on payments. 

Individuals have the ability to use these loans for any purpose. Many use it for medical emergencies, unexpected events, debt consolidation, etc. 

These loans are typically good for individuals with good credit because these individuals are at low risk of defaulting. Lenders determine this by checking if they have been reliable and consistent when making loan payments, and if so, then they will most likely lend money to the borrower. 

There is a set repayment period for the borrowers to repay the loan, and this usually ranges from 24 to 60 months, or sometimes even longer, depending on the loan. 

If the loan does not get paid back in time, many lenders allow a grace period before they start reporting late payments to credit bureaus. If the borrower allows the loan to continue to go unpaid, it will affect their credit score, and they will have to pay late penalties as well. 

What happens if an unsecured loan does not get paid?

Let's understand this by taking a look at the table below:

0-30 days A grace period to make payments without penalties
30-60 days Late fees and possible penalties like an increased interest rate may occur. This can also be reported as a late payment to credit bureaus and will lead to your credit score dropping
60-120 days The lender is now capable of asking for the full amount owed. Your account will be flagged by the lender’s collections department, which will lead it to be moved to default status. Credit card accounts are at risk of being closed at this point.
120-180 days Debt is discharged by the lender as a loss and sold to a collection agency, now, the lender cannot collect any debt. Legal action can and may be taken at this stage, or as an alternative, debt settlement could be proposed.
270 days Student loans become default at this stage because these loans have the longest grace period of all unsecured debt

Signature Loan vs. Revolving Credit 

Revolving credit is when a borrower is given a credit limit, the maximum amount you can spend on that particular account.

The big difference between revolving credit and an unsecured loan is the funding delay that occurs when a potential borrower applies for revolving credit. This is due to the bank or financial institution having to check the potential borrower's credit history and qualifications.  

Unlike revolving credit, a signature loan will be deposited more quickly, and this gives the borrower the opportunity to use the funds that were given to them at a later time.

Qualifications required for a Signature Loan 

They are provided by many participating financial institutions, which include banks, online lenders, and credit unions

In order to qualify for an unsecured loan, lenders measure the risk by checking factors to make sure a borrower will repay the loan

1. Income

Lenders like to lower the risks. To do that, they ensure the borrower has sufficient income to make loan payments. It is possible lenders will ask to see proof of income, such as a recent pay stub. 

2. Debt-to-income ratio

Lenders use the debt-to-income ratio to measure the borrower's ability to repay a loan. 

To calculate the debt-to-income ratio (DTI), you have to add all your monthly debt payments and divide that by your gross monthly income. 

For example, if you have $800 worth of debt payments and $4,000 in gross income each month, then your DTI is 

$800/ $4,000 = .2 or 20%

Lower ratios are better. Each lender has different requirements for DTIs. However, a percentage higher than 43% is usually not acceptable. 

3. Assets

Some lenders like to know if the borrowers have saved. This shows responsibility because the borrower is less likely to miss out on loan payments. Having money in your savings shows you are prepared for any financial emergencies. 

4. Credit

To see if you qualify for the unsecured loan, lenders check the potential borrower's credit report. This is to look over how they have managed any previous loans and credit cards. They look for on-time payments, responsible credit use, as well as credit scores. 

Individuals with a credit score of 700 and higher qualify and are usually the ones given the best interest rates. 

How to apply for an unsecured loan

After looking at all possible options, and figuring out whether an unsecured loan is what is best for you, here are the steps to apply for one:

1. Determine exactly how much you need: Borrowing what you need is important so there is no confusion. Borrowing too much can lead to too many risks. 

2. Start the application process: This can be done online or in person at the lender branch. This is where you just give basic financial and personal information to the lender. 

3. Prequalify to check your APR: Annual Percentage Rate is a yearly interest. Not all lenders provide prequalification, but for the ones that do, you can see the type of loan terms you qualify for through a soft credit check. 

4. Provide documentation: This includes recent pay stubs, bank statements, etc. Lenders can ask for proof of identification from things such as a driver's license or passport. 

5. Apply for the loan: The lender will perform a hard credit check, and they will use your financial information to determine how much money they are willing to lend to you, the interest rate for the loan, as well as the fees they will charge you for the loan. 

6. Get approved for the loan funds: The disbursement is quick; many individuals get the money the same day their application is approved. 

Researched and authored by Nikaila Alim | LinkedIn

Reviewed and Edited by Sakshi Uradi | LinkedIn

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