Unsecured loans: What are they and how do they work?

An unsecured loan is a type of debt that doesn’t require collateral. Collateral is an asset that a borrower puts down to back or secure a loan. Because unsecured loans aren’t backed by collateral, lenders may rely more heavily on a borrower’s creditworthiness when making lending decisions.

Learn more about how unsecured loans work and how to get an unsecured loan. 

What you’ll learn: 

• Unsecured loans don’t require collateral. 

• Without collateral, unsecured loans may have higher interest rates than secured loans.

• Creditworthiness might also take on more importance when lenders review applications for unsecured loans. 

• Some credit cards, personal loans and student loans are examples of unsecured loans. 

A borrower doesn’t have to put down collateral to get an unsecured loan. In some cases, unsecured loans may have higher interest rates and stricter eligibility requirements than secured loans. But that’s not always the case. Unsecured credit cards, for example, often have lower interest rates than secured credit cards. It depends on the lender, applicant and loan type.

The major differentiating factor between secured and unsecured loans is whether the loan requires collateral. Secured loans do require collateral while unsecured loans don’t. 

With a secured loan, on the other hand, the borrower needs to secure the loan with collateral. That could be a physical asset, such as a car or house. Or it could be liquid assets, such as cash or investments. If the borrower can’t pay back the secured loan, the lender can take that collateral to cover their losses.

Each lender has its own policies and requirements, whether a loan is unsecured or secured. 

But typically, when someone applies for an unsecured loan, the lender will use things like credit scores and reports to assess their creditworthiness. Creditworthiness is a measure of how likely someone is to pay back a loan on time. 

Because unsecured loans aren’t backed by collateral, creditworthiness takes on additional importance when the lender decides whether to approve or deny unsecured loan applications. If the application is approved, the lender also sets the loan terms, including payment schedule and interest rate. 

Generally, people with higher credit scores are more likely to get approved with better terms. But lending decisions are complex, and many factors can come into play. Plus, loan type can play a big part. Student loans may not have the same credit score requirements as unsecured credit cards, for example. To find out more about a particular loan, read its eligibility criteria and terms in full.

Unsecured loans can be split into two basic categories: installment loans and revolving credit accounts. 

Installment loans give the borrower a lump sum up front that’s paid off in regular installments over a set period of time. Here are a couple of examples of unsecured installment loans: 

• Student loans

• Unsecured personal loans

Revolving credit accounts can be used and paid down repeatedly, up to their credit limit, as long as the account remains open and in good standing. They include:

• Unsecured credit cards

• Personal lines of credit

Because unsecured loans don’t require collateral, you don’t have to put up your house, car, investments or any other collateral to get one. 

Some unsecured loans may have higher interest rates and stricter eligibility requirements than secured loans. But that’s not always the case. Loan terms can vary by lender, loan and more. In fact, some unsecured loans may offer better terms than their secured counterparts. 

As with any other kind of debt, if you make late payments or default on an unsecured loan, it can hurt your credit. And the lender can send the loan to collections or sue you to recoup the unpaid debt.

You may be able to get an unsecured loan from places like banks, credit unions and online lenders. Each lender has its own application process. But here are a few general guidelines on how to get an unsecured loan:

Before moving forward with any loan, it can help to read up on that loan’s eligibility criteria to see whether you might qualify. Getting pre-qualified or pre-approved may help narrow down your options. 

You may also want to check your credit scores to know where you stand. CreditWise from Capital One is a free tool that lets you monitor credit and keep up with changes. The CreditWise Credit Simulator can even calculate how actions like applying for a loan or paying down your balance might affect your credit scores.

Next, it’s time to take a closer look at the loan’s terms. Here are a few things to look into: 

• Interest rates, including introductory offers

• Monthly payment 

• Fees

• Loan term

• Payment schedule 

These are just a few examples of things to look out for. Make sure to read the loan terms in full before applying.

Once you choose an unsecured loan, it’s time to submit your application. The process of applying for a loan may vary by lender and loan type. But generally, you’ll need to have some personal information, such as address, income and employer, on hand.

Here’s some more information about unsecured loans.

An unsecured loan is a type of debt that doesn’t require collateral. Unsecured credit cards, student loans and personal loans are a few common types of unsecured loans. 

Capital One has secured and unsecured credit cards for people at many credit levels. You can check for pre-approved card offers before you apply. The process is quick and won’t hurt your credit scores.