Mastering Signature Loans: Pros, Cons and More Tips - 2023

What Is a Signature Loan?

A Brief introduction

A signature loan, also known as a good faith loan or character loan, is an unsecured personal loan that doesn't require any collateral. Instead, it's based solely on the borrower's creditworthiness and their promise to repay the loan.

How It Works

Lenders will examine the borrowers' credit score, repayment history, and income to determine whether to grant a signature loan. If approved, borrowers can receive a lump sum deposit and need to repay the agreed-upon monthly loan payment within a certain period of time, normally ranging from 24 to 60 months, just like other types of personal loans.

Since there's no collateral involved, the approval process can be quicker than for other types of loans. However, due to the lack of collateral, interest rates for signature loans may be higher than secured loans, as lenders face a higher risk.

Common Terms for Signature Loans

Since a signature loan is a type of personal loan, the terms and structure don't make a huge difference, but the borrower's signature and will become the collateral in this case. The borrower still needs to make the same monthly payment along with the interest throughout the whole loan life cycle.

Loan terms can range from a few months to several years, depending on the lender and the borrower's needs. So you need to understand the terms and conditions of your signature loan before agreeing to it, including the fixed interest rates and the predetermined repayment schedule.

Where Can You Use Signature Loans?

Debt consolidation

Debt consolidation is a process that allows borrowers to combine multiple high-interest debts, such as credit card balances and other personal loans, into a single lower-interest loan, which can be one signature loan. This method can simplify the repayment process, since you only have to pay one loan now, and potentially save you interest costs.

Suppose you has three credit cards with $15,000 balances in total and the APR ranging from 18% to 27% based on today's data. You will be better off if choosing a signature loan for the same $15,000 amount with 12% interest rate to pay off all the credit card balances. By consolidating their debt into a single signature loan, the borrower can simplify their repayment process and potentially save money on interest over time.

Emergencies

Signature loans can also be used to cover unexpected expenses or emergencies. Since the approval process can be relatively quick, borrowers can access funds to handle urgent situations like medical bills, car repairs, or home repairs without the need for collateral.

Major life events

Signature loans are also useful for financing major life events, such as weddings, vacations, or moving expenses. The loan can help significantly when you have steady income but cannot or do not want to take out from your savings or rely on high-interest credit cards.

Others

In addition to these common uses, signature loans can be used for various other purposes, such as home improvements, education expenses, or even starting a small business.

Pros and Cons of Signature Loans

When considering a signature loan, it's recommended to weigh the pros and cons to make the right financial decision.

Subtitle: Pros

• No Collateral Required: Signature loans are unsecured, which means borrowers don't need to put up any collateral, such as their home or car, to obtain the loan.

• Quick Approval Process:Since there's no need to evaluate collateral, the approval process for signature loans can be faster compared to secured loans.

• Fixed Interest Rates and Repayment Terms: Just like other installment loans, signature loans provide a fixed interest rate under the specific repayment periods. Borrowers can benefit from the certain repayment plan to manage the monthly budget wisely.

• Versatility: Borrowers can use signature loans for various purposes.

Cons

• Higher Interest Rates: Since your promise and willingness to repay is the only collateral, signature loans often have higher interest rates to cover the default risks in comparison with other secured loans.

• Creditworthiness Requirements: Signature loans generally require borrowers to have a good credit score and stable income. Those with poor credit or limited credit history may have difficulty obtaining a signature loan or may face higher interest rates.

• Potential for Increased Debt: The money won't come freely, and the principle also applies to signature loans. If the borrowers don't have feasible budgeting and repayment plans, it can be difficult at every due date. In the worst case, this late payment or missing payment can hurt your credit history badly.

• Penalties for Late or Missed Payments: Failing to make timely payments on a signature loan can result in late fees or other penalties, and can negatively impact the borrower's credit score.

When Should You Use Signature Loans?

Signature loans can be an expensive option, depending on the interest rate you secure.

Before applying for as signature loan, ask your self the following questions first:

- Do I really need this loan?

- How should I use the loan?

- Is my income sufficient to cover the payments?

- Will the loan provide a better financial situation in either short-term or long-term?

One appropriate use for a signature loan is debt consolidation as we explained before.

Ideally, other unexpected expenses should be covered using an emergency fund or other savings. However, not everyone has access to such funds. A Federal Reserve survey found that 32% of Americans do not have enough savings to cover an unexpected $400 expense in 2021 (up to 50% in 2013). In such cases, a signature loan could be a viable option.

In summary, you should evaluate your financial situation and the purpose of the loan before applying for a signature loan.

How to Get a Signature Loan?

Where to Apply

There are several sources from which borrowers can obtain signature loans:

Banks:

Traditional banks are a common source for signature loans. Borrowers with an existing banking relationship may find it easier to get approved for a loan with their bank.

Credit Unions:

Credit unions are member-owned financial institutions that often offer signature loans to their members. They may offer more competitive interest rates and better terms compared to traditional banks. Please be aware that the loan offers provided by credit unions are exclusive to its members.

Online Lenders:

Online lenders provide an alternative to traditional financial institutions, often offering a streamlined application process and faster approval times. Signature loans are widely offered by online lenders. Online lenders usually have more competitive offers and more flexible eligibility requirements due to their lower operating costs compared to traditional banks and credit unions. Additionally, most online lenders allow you to check estimated rates and terms without running your credit report.

How to Apply

The application process for a signature loan typically involves the following steps:

1. Research: You should start by researching various lenders and comparing interest rates, loan terms, and eligibility requirements to find the best fit for your needs.

2. Gather Documentation: Lenders may require proof of income, credit history, and other financial information. You should gather necessary documentation, such as pay stubs, tax returns, and bank statements, before applying.

3. Complete the Application: You need to complete a loan application, either online or in person, providing their personal and financial information. This may include details about your income, employment, and credit history.

4. Wait for Approval: After receiving your application, the lenders will conduct a review process and issue a decision letter based on the information provided. Sometimes, the lender may require supplemental documents from the borrower before making a final decision. This review process may take anywhere from a few hours to several days, depending on the lender.

5. Sign the Loan Agreement: If approved, borrowers will receive a loan agreement outlining the terms and conditions of the loan. They should carefully review and sign the agreement before receiving the loan funds.

6. Receive the Funds: In this step, the lender will provide a comprehensive contract with specific terms and interest rates to the borrower. Once the loan agreement is signed (either in ink or electronically), the lender will issue the funds shortly thereafter. The repayment schedule will start according to the terms specified in the contract.

Tips for Getting a Signature Loan

Tips for Success

• Check Your Credit Score: Lenders typically require a good credit score for signature loan approval. Before applying, check your credit score and address any discrepancies or issues on your credit report.

• Improve Your Credit: If your credit score is less than ideal, work on improving it before applying for a signature loan. This may include, but is not limited to, paying down outstanding debts, disputing errors on your credit report, and making on-time payments on existing loans and credit cards.

• Compare Lenders: Research various lenders to compare interest rates, loan terms, and eligibility requirements.The more you research, the better rates and terms will be.

• Gather Financial Documentation: Be prepared to provide documentation, such as pay stubs, tax returns, and bank statements, when applying for a signature loan.

• Limit Loan Applications: Submitting multiple loan applications within a short period can negatively impact your credit score. Limit the number of applications and only apply for loans you're confident you can repay.

• Consider a Cosigner: A cosigner can be a helpful source for getting a loan approved if you have limited credit history or don't meet the income requirements of a loan. However, this only works if the cosigner has a better credit score or sufficient income after subtracting all debts. Otherwise, the cosigner won't be able to increase the odds of loan approval.

Factors to Consider

• Loan Amount and Ability to Repay: Borrow only what you need and can realistically repay. You should know that the loan payment will add to your monthly expenditure schedule and won't go away for a while. This means that your previous spending plan needs to be adjusted when taking a new loan. Even if it is for debt consolidation, you cannot make only the minimum payment for your credit card, but you must pay a larger fixed amount every month, and late or missed payments can result in fees and damage your credit score.

• Interest Rates: Compare interest rates from different lenders to find the most competitive rate for your signature loan.

• Loan Terms: The loan term can significantly impact your monthly payment amount and total interest cost over the loan's lifecycle. To put it simply, a longer term gives you more flexibility in the short term, but comes with higher interest costs, and vice versa.

• Fees and Penalties: Be aware of any fees associated with the loan, such as origination fees or prepayment penalties, as these can affect the overall cost of borrowing.

Signature Loan vs. Personal Loan

Signature Loan

A signature loan is one of the unsecured personal loans. As we covered earlier, key features of signature loans include:

• No collateral required.
• Fixed interest rates.
• Set repayment terms.
• Dependence on credit score and income for approval.

Personal Loan

A personal loan is a widely used financial product that includes various types of loans, such as secured and unsecured loans, debt consolidation loans, installment loans, and many others. A signature loan falls under the unsecured loan category.

The main features of a signature loan include:

• Can be secured or unsecured.
• Fixed or variable interest rates.
• Set repayment terms.
• Approval may depend on credit score, income, and collateral (for secured loans).

Signature Loan vs. Revolving Credit

Signature loans, and revolving credit serve different purposes and offer varying levels of flexibility and accessibility.

What's Revolving Credit?

Revolving credit is a flexible financing option that provides borrowers with continuous access to funds up to a predetermined limit. When borrowers repay their balance, their available credit increases, allowing them to draw funds again without reapplying. Credit cards and home equity lines of credit (HELOCs) are the most common examples of revolving credit.

Method of Funding

Signature loans offer a one-time lump sum of funds with a fixed repayment term, revolving credit provides ongoing access to funds with flexible repayment options.

Funding Speed Comparison

When applying for a signature loan or revolving credit, the lender will evaluate the borrower's qualifications before initiating the funding process. Usually, signature loans have a faster funding process than revolving credit. However, the processing time can be affected by various factors. For instance, if you have received a pre-approved letter for a credit card, the entire process can be completed in a few seconds when submitting your application online.

Account Status After Payoff

Once a signature loan is fully repaid, the account is closed, and borrowers must apply for a new loan if they need additional funds in the future.

In contrast, with revolving credit accounts, borrowers can repay their loan while keeping their line of credit open. This type of credit allows the borrower to continually access funds under a certain limited amount as long as the account remains active. Alternatively, the borrower and lender can decide to end the relationship and close the account.

Alternatives to Signature Loans

While signature loans can be a convenient option for obtaining unsecured funds, they may not always be the best choice for everyone. Therefore, as we understand that everyone has a unique financial status, here are some alternatives if signature loans do not meet your requirements:

Other Personal Loans:

Personal loans come in various forms, including secured and unsecured loans. Interest rates and repayment terms will vary, so you can choose the loans according to your needs.

Personal Lines of Credit:

A personal line of credit is a flexible borrowing option that allows you to access funds as needed, up to a predetermined credit limit.

Credit Card Cash Advances:

If you have a credit card with an available cash advance option, you can access funds quickly and easily. The amount that can be borrowed is usually limited to a certain percentage of the borrower's credit limit. However, be aware that cash advances typically come with high interest rates and fees. For example, Chase bank charge 5% fees for each request and yield Maximun 29.99% APR.

Peer-to-Peer Lending:

Peer-to-peer (P2P) lending platforms connect borrowers directly with individual investors or lenders. Compared to a signature loan, P2P lending offers interest rates ranging from 6% to 36%, with origination fees ranging from 1% to 8%, depending on the platform you choose. Some lenders offer a 0% origination fee option and provide very competitive rates.

Home Equity Loans or Lines of Credit:

If you own a home with substantial equity, you might consider a home equity loan or line of credit. These options allow you to borrow against the value of your home. In most cases, they come with an adjustable interest rate instead of a fixed one, and they do not allow you to refinance your mortgage while you have a HELOC. Therefore, if you are considering refinancing your mortgage with a lower rate, you want carefully evaluate the terms before taking HELOC.

Borrowing from Friends or Family:

In some cases, borrowing from friends or family may be a suitable alternative to signature loans. This option gives a lot more flexibility than taking loans from banks or other financial institutions. It depends on the verbal or written agreement between the parties. However, it's essential to ensure that both parties have a clear understanding of the borrowing agreement to avoid misunderstandings and strained relationships.

Credit Union Loans:

If you're a member of a credit union, you may have access to personal loans with lower interest rates and more flexible terms than traditional signature loans. Credit unions are member-owned financial institutions, which means they provide financial products exclusively to their members.

Payday Alternative Loans (PALs):

Payday Alternative Loans (PALs) are another type of small amount, unsecured loan that is only available for federal credit unions. The capital cost is relatively lower than a Payday Loan, but it still comes with high APRs and short repayment terms. As mentioned above, this loan also serves the members of credit unions.

Payday Loans:

Payday loans are typically small, short-term loans that are meant to be repaid on the borrower's next payday. Payday loans, usually requiring a pay stub and determined by your earnings, often entail high interest rates and fees, with potential for additional charges or rollover into a new loan if not repaid by the due date.

401(k) Loans:

If you have a 401(k) retirement plan, you may be able to borrow from it in times of financial need. 401(k) loans are not traditional loans, as they lack a lender and credit evaluation, but rather allow access to your retirement funds, typically up to $50,000 or 50%, whichever is less. Also, withdrawing funds before reaching the retirement age of 59 ½ usually results in income taxes on any earnings, and potentially a 10 percent additional penalty.

FAQs

What Distinguishes a Signature Loan From Other Personal Loans?

A signature loan is a form of personal loan that is unsecured, meaning that the borrower's signature and promise to pay are the only collateral required. This distinguishes signature loans from other personal loans that may require your car or house as collateral.

Who Are Good Candidates for Signature Loans?

Borrowers with an excellent credit history and sufficient income are considered good candidates for signature loans. These characteristics indicate that the borrowers have less default risk.

What Is the Minimum Amount That Can Be Borrowed With a Signature Loan?

The minimum amount that can be borrowed with a signature loan can vary, but it typically starts at around $500.

Are Signature Loans Available at All Banks and Credit Unions?

No, not all banks and credit unions offer signature loans. It is important to consult with your financial institution to determine whether they offer signature loans and to understand the associated terms and conditions.