What is a signature loan?

“Sign here. And here. Initial here. Put the date here.”

Does this sound familiar? If so, you’ve likely applied for some kind of loan. Personal loans, mortgages, and business loans are some of the most common types of loans. But what category does a signature loan belong to?

A signature loan is a personal loan, which consists of money borrowed from a financial institution that you pay back in fixed monthly payments. You can spend the funds from a signature loan in any way you see fit. This is the opposite of loans like mortgages and auto loans, which must be used for a specific purpose. The funds from a mortgage, for example, must be used to purchase a home that has been approved by the lender.

However, a borrower can spend the money from a signature loan on any item or service they choose. Common uses include large purchases, emergency expenses, and debt consolidation. Do you need some extra cash to pay for a wedding, a home improvement project, or a large medical bill? These are all scenarios in which you could use a signature loan.

Signature loans are often unsecured. This means you don’t need to use any of your assets as collateral for the loan. In contrast, a secured loan holds specific assets that you own as collateral to ensure repayment. A mortgage is a common type of secured loan that holds your home as collateral. Your car is another example of collateral that may be used in a secured loan. 

At this point you may be wondering, “If a signature loan can be spent on anything and is unsecured, how does it even work?”

How does a signature loan work?

A signature loan is sometimes referred to as a “good faith” loan. This is because the loan requires only your signature to demonstrate your commitment to pay back the money.

Many loans, such as mortgages, require an asset (e.g., your house) as collateral to secure the loan. With a signature loan, however, there’s no collateral involved. So if you fail to make payments on the loan, the lender cannot go after your assets to recover their losses.

Failure to pay a signature loan isn’t without consequences, though. If you miss payments, this will negatively impact your credit score. This may seem minor until you try to rent the perfect apartment downtown by all the best coffee shops or apply for your favorite store’s credit card. A poor credit score will hurt all of your future credit applications.

Since signature loans are not secured with collateral, a key factor in the qualification process is your credit score. However, good credit is not the only thing lenders assess in a loan application. There are four primary considerations to qualify for a signature loan:

  1. Good credit. Your credit score is a three-digit number ranging from 300–850, with 850 being the best. This score is based on the information in your credit files and represents your creditworthiness (i.e., how likely you are to repay a debt). Credit scores are important when you’re applying to borrow money from an institution.
  2. So what credit score do you need?

    Different lenders have different credit score requirements for signature loans. In general, 630–689 is considered fair credit. In this range, it will be more difficult to obtain a loan than if you had good or excellent credit, but it’s still feasible. Some lenders will accept credit scores between 600–630, but your options will be very limited if your score is below 600.

  3. Adequate income. When you apply for a signature loan, your lender will want to know that you can repay the debt. Having a stable and sufficient income instills confidence that you’ll be able to make your loan payments. Lenders have different views on what constitutes “adequate” income. The documents required to prove your income, though, are fairly standard and typically include
    • Pay stubs
    • A W2 or tax return
    • Direct deposit statements

    Other potential document types include payroll schedules, statements demonstrating retirement income, or a signed letter from your employer.

  4. Low existing debt. While income is an important piece of the loan application, lenders will also look at your debt-to-income ratio. Even if you make good money, having a high amount of existing debt can be problematic for your loan application. Lenders tend to look for individuals with a track record of responsible debt management. This means keeping your credit card balances low and maintaining a reasonable level of debt. Generally speaking, you should strive to keep your credit card balances under 10 percent of the credit limit.
  5. Permanent address and job. Another factor lenders consider is the perceived stability of your situation. Having a permanent address is essential. Also, a consistent paycheck implies that your income will remain constant throughout the term of the loan. Additionally, individuals with a family and other local obligations may appear to be less of a “flight risk.”

What’s the typical interest rate on a signature loan?

Since there’s no collateral, the interest rates for signature loans are often higher than other types of credit. Additionally, the APR (annual percentage rate) will depend on your credit score. Individuals with higher credit scores may be able to secure more favorable APRs.

Here’s a breakdown of the average interest rates for personal loans in 2019:

  • Excellent credit score (720–850): 10.3–12.5 percent APR
  • Good credit score (680–719): 13.5–15.5 percent APR
  • Average credit score (640–679): 17.8–19.9 percent APR

E-signatures for financial documents

Person signing a document on a tablet

As the name implies, the actual signature is an essential aspect of a signature loan. Since there’s no collateral, your signature is your bond — it represents your promise to repay the loan. Given the emphasis on the signature, you may be wondering if an electronic signature is sufficient for a document of this importance. The answer is yes.

E-signatures are now very popular within the financial world, and they’ve been legally permissible for nearly 20 years. They were first legalized with the E-Sign Act back in 2000 and continue to meet regulatory compliance standards.

E-signatures have some notable benefits over traditional paper-and-ink signatures. They’re more convenient and can be completed within a shorter time frame. The speed and convenience make the loan application process quicker and easier. For this reason, electronic signatures are well suited to signature loans. They carry the legitimacy of a traditional signature, but without the hassles of printing, scanning, or driving to the bank.

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