What is a Signature Loan?

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Definition:

A signature loan is a type of personal loan where the borrower doesn't provide collateral, offering just their signature as a sign of their intention to pay the loan back.

🤔 Understanding signature loans

When a bank or other financial institution lends money to a customer, it can provide either a secured or unsecured loan. Secured loans are covered by some form of collateral. For example, the value of the home purchased secures a mortgage. Unsecured loans don't have any asset backing them. Instead, the bank is taking the borrower's word that they'll pay back the loan. An unsecured loan, where the only thing that the borrower offers is their signature and a promise to pay back the money they borrow, is a signature loan. In issuing a signature loan, banks typically look for a solid credit history and proof of sufficient income to repay the loan. A co-signer may be required; the co-signer would be on the hook if the original borrower failed to repay the loan.

Example

The most common example of a signature loan is an unsecured personal loan. Many banks and lenders offer small loans to customers without requiring collateral. Instead, they look at the customer's credit history and use that to decide on maximum loan amounts and interest rates. If the loan is approved, the borrower signs the paperwork and promises to make their monthly payments.

Takeaway

A signature loan is like making a promise to the bank and relying on your reputation to back it…

With a secured loan, lenders take your word that you'll pay the money back — but they have some recourse if you stop making payments. For example, the lender could foreclose on your home or repossess your car. With a signature loan, the lender doesn't have any collateral that it can take away if you stop making payments. Instead, the only thing backing your promise is your reputation as a good borrower.

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What is a signature loan?

A signature loan (also called an unsecured loan) is a type of personal loan where the borrower does not have to provide collateral.

Collateral is something of value that the lender can use to secure the loan, reducing its risk. For example, a mortgage uses the real estate the borrower purchases as collateral. If the borrower fails to make payments, the lender can foreclose on the real estate, take possession of it, and sell it to recoup its losses.

With a signature loan, the only thing that the bank has to secure the loan is the borrower's promise of repayment and their signature on the loan agreement. Because there is no asset securing a signature loan, these loans tend to be more expensive than secured loans like mortgages or auto loans. That means you may pay more fees and/or higher rates of interest when using a signature loan.

Signature loans also tend to be more challenging to qualify for. Because the only thing that the lender has to go on is your reputation for making payments, you generally need to have a good credit score to qualify. People with less than perfect credit usually have better luck qualifying for secured loans than unsecured ones.

How does a signature loan work?

Signature loans work like most other loans. The thing that sets them apart is the fact that you don't need to provide collateral when getting the loan.

The first thing to do when getting a signature loan is to choose a lender and submit an application. Typically, the borrower has to include identifying information like their name, address, and Social Security number. They also include financial information, such as their annual income and their reason for applying for the loan.

The lender receives and reviews the application. As part of the review process, the lender usually checks the applicant's credit report. The lender looks at the report to ensure that the applicant has a good credit score and a history of paying back their loans. The better the borrower's credit, the better the terms they typically receive when getting a loan.

If the lender approves the loan, they provide the funds to the borrower, often by depositing the money to the person's checking account. The borrower is then free to use the money as they wish unless the loan agreement specifies restrictions on the use of the funds.

Before receiving the disbursement, the applicant will need to agree to the offered loan amount, term, and interest rate.

Each month, the borrower gets a bill and must submit payment. Missing payments or making late payments may incur fees and damage the borrower’s credit score.

What is the difference between a signature loan and revolving credit?

The primary difference between a signature loan and revolving credit is when the borrower can access funds.

With a signature loan, the person borrowing money gets all of the money as one lump sum. If they apply for a $30,000 loan, they'll get $30,000 from the lender on the first day of the loan (minus applicable fees, such as origination fees). They cannot later get additional money from the loan without submitting a new application, even if they've paid down their loan balance.

With revolving credit, the borrower can borrow additional money at any time, up to their credit limit. One of the most common examples of revolving credit is a credit card.

You could receive a $10,000 credit limit, but you don’t need to borrow the $10,000 all at once. You can use some of that limit, pay your balance, then take more from the line of credit later without submitting a new application.

How do you qualify for a signature loan?

Because there is no asset securing a signature loan, they can be more challenging to qualify for than other types of loans. With a signature loan, one of the most important things determining whether you are eligible is your credit report and credit score.

Your credit report has information about your interactions with credit, such as different loans that you've received, your history of making payments toward those loans, and any negative marks, such as accounts in collections. The better your credit score, the better your chances of qualifying for a signature loan. Better credit can also help you reduce fees and the interest rate that you'll have to pay.

Depending on the lender, you might also have to provide personal or financial information with your application. For example, you may be asked to prove your annual income by providing copies of your pay stubs from work or tax returns. Ask your lender what they need when you apply for a loan.

What credit score do you need for a signature loan?

Credit scores range from a low of 300 to a high of 850. The higher your credit score, the better your odds of qualifying for a signature loan. Higher credit scores also help you secure lower interest rates and fees for the loans you receive.

For a signature loan, lenders typically look for scores of 670 or better. It is possible to qualify for a signature loan with lower credit scores, but you'll have fewer lenders to choose from, and you'll likely pay a higher interest rate.

How does a signature loan affect credit ratings?

Like any loan, a personal loan can be good or bad for credit scores.

For example, having a signature loan can improve credit mix, showing lenders that the borrower has experience with different types of loans. If they make their monthly payments before the due date, it also helps build a good payment history, which can boost scores.

On the other hand, missing payments can damage credit scores. Applying for a new loan can also increase the borrower's total debt and place another credit inquiry on their report, temporarily reducing their score. Handling the loan well and paying it down according to the schedule should ultimately help credit as it improves your payment history.

How are signature loans used?

Personal loans are best for relatively short-term, low-cost borrowing. Personal loan amounts generally fall into the $3,000-$35,000 range, though some lenders offer smaller or larger loans. Terms usually range from one to five years.

This makes signature loans ideal for things like consolidating other debts, covering unexpected bills like medical bills, or one-time expenses like a car repair.

For longer-term borrowing or more significant needs, like buying a car or a home, you'll probably be better off with a secured loan of some type.

Signature loans are also best for people who have good credit. People with less than perfect credit may be able to qualify for such a loan, but they will typically pay very high interest rates, making secured loans a better deal for them.

If you have less than great credit, one thing to keep in mind is that secured loads, like mortgages and auto loans tend to have better interest rates and fees than personal loans. Unsecured, personal loans are good in the relative sense, meaning they’re typically better than credit card debts or payday loans. There are also secured personal loan options that will offer better terms than unsecured loans.

It’s also important to be on the lookout for less scrupulous lenders who market their loans as personal or signature loans. Unscrupulous lenders can charge huge interest rates and fees to trap you in a cycle of debt.

What is an example of a good signature loan?

When choosing a signature loan, you should comparison shop to get the best deal possible.

Some of the things that you should compare are:

  • Loan term
  • Loan minimum and maximum
  • Fees
  • Interest rates

Ideally, the loan that you choose should be sufficient to meet the expense that you need to cover and with a term that results in a monthly payment that fits in your budget.

Fees and interest rates are also incredibly important. Higher fees and interest rates result in costlier loans. All else being equal, opt for the loan with the lowest total cost.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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