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?

Personal lending is the fastest growing category of consumer lending and 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. Signature loans are unsecured and are often made based on the lender’s credit rating and/or employment.

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.

Imagine you have several large credit card debts accruing interest at rates of 20 percent or more. A bank might offer you a signature loan at a lower interest rate. After you pay off your credit cards with the loan, you then pay back the loan amount to the bank. You save money because the debts are consolidated and the interest on the loan is reduced.

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.

In the wake of the 2008 credit crisis, signature loans became a popular choice because they don’t put your home equity at risk. However, because there’s no collateral, a financial provider might demand higher interest. Alternatively, they could demand a more stringent repayment schedule.

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

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How does a signature loan work?

A signature loan is sometimes referred to as a “good faith loan” or “character 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. Interest rates range anywhere from 5 to 30 percent and depend on the payer’s circumstances and credit record. 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:

  • 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

What are repayment methods of signature loan?

Before taking out a loan, always compare different financial providers, the products they provide, and the fees they charge. Shop around to find the best option for your situation. Repayment methods for signature loans can vary; they include

  • Variable rate. The interest rate is based on a changing index and can fluctuate over time.
  • Fixed rate. The interest rate remains the same for the life of the loan.
  • Payday. Also called cash advances, these small, short-term loans often have higher interest.
  • Convertible. This type of loan can convert into shares or stock and often has lower interest.
  • Single-payment. The principal and interest on this type of loan is repaid in one payment on an exact date.

Some financial providers, like SoFi, consider more information than a borrower’s credit score. They also consider your occupation, education, and the possibility of a cosigner.

E-signatures for financial documents

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 usually 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.

AS ALWAYS, CONSULT AN ATTORNEY BEFORE RELYING ON ANY FORM CONTRACT OR  CONTRACT TEMPLATE. THE CONTENT ABOVE IS FOR INFORMATIONAL PURPOSES ONLY.

This article is originally published on Jul 03, 2019, and updated on Dec 02, 2022.

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