Signature loans are personal loans extended to individuals. They’re generally small, always unsecured and generally have terms lasting for less than five years.

Here’s how they work.

What Is a Signature Loan?

A signature loan is a form of unsecured credit extended by banks or other lending institutions. They don’t require collateral, which distinguishes them from something like an auto loan or a mortgage which is secured by the underlying asset. This is why signature loans are referred to as “unsecured,” because there is nothing that the lender can seize in the event of nonpayment.

Instead a lender issues a signature loan based on four main factors:

  • Credit score;
  • Income;
  • Interest rate;
  • And signature.

The last is where a signature loan gets its name. As the borrower you sign a document promising to make payments. The lender has no other guarantee of payment.

Signature Loan Terms

A signature loan is a form of personal loan. In fact, generally when someone refers to a “personal loan,” this is what they’re talking about.

You receive a signature loan in one lump sum. This distinguishes a signature loan from a credit card or a line of credit. These can also be forms of personal lending, but in those cases the lender agrees to an upper limit of borrowing and you take out money as you need it. In a signature loan you receive an agreed upon amount up front.

They are generally small. Signature loans can vary in size from as little as $1,000 to $50,000 or more (for borrowers with exceptionally high incomes and great credit). The average signature loan is for approximately $11,000. 

Signature loans are also generally short term. Most expect payment in five years or less, but some can have terms as short as 12 months.

This is not necessarily a bad thing though, because signature loans also tend to have higher interest rates than most forms of borrowing. This depends heavily on the credit score of the borrower. If you have better credit, you will get better terms on your loan. Other borrowers can have interest rates higher than most major credit cards.

One study by ValuePenguin and LendingTree found that the average interest rates for personal loans (such as signature loans) can range from 10% to 36% or higher. For individuals good or excellent credit (generally a score of 680 or higher) a signature loan can typically carry interest rates as high as 15.5%. 

Prepayment Penalties

One important clause to look for when taking out a signature loan is what’s known as “prepayment penalties.” These are common in many forms of lending.

This is a penalty that the lender charges for paying off your loan faster than the terms anticipate. Lenders include the penalties because with an early payment you spend fewer months paying interest, which means they make less money.

Signature Loan Process

Getting a signature loan is typically straightforward;

  • Application – The lender will have you fill out paperwork to apply for the loan and authorize a credit check. They will typically review your credit score, your income and other major assets, and any other debts you currently owe.
  • Offer – If the lender approves this loan, they will offer you terms. Typically this will involve telling you how much money they can lend you, what interest rate they will charge, and the duration of the loan.
  • Receipt – The lender will issue the funds to you. Repayment will typically begin soon thereafter.

Note that borrowers with weak credit will likely have higher interest rates and smaller loans offered to them.

If you cannot get a loan, or cannot get one approved on terms you want, you have two common options. The first is to find someone willing to cosign this loan with you. The lender will then set the terms of the loan based on this individual’s credit and income, as they have promised to make payments in the event that you default.

The second option is to stake collateral. In this case, you would turn the loan into a secured loan based on some asset you own with value comparable to (or greater than) the amount in question. For example, someone might use their car or home as collateral for a loan like this. In this case the lender may agree to more lenient terms, given that in the event of default they can either place a lien on the asset or seize it outright.

Signature Loan vs. Line of Credit

Another common form of personal lending is the line of credit. Credit cards are the most common forms of credit lines extended to individual consumers.

A signature loan differs from a line of credit in two main ways. First, you receive the money up front, in one lump sum. With a line of credit your lender establishes an upper limit and you can borrow freely under that amount. Second, a line of credit typically has no prepayment terms. You can pay as much or as little as you want so long as you meet any minimum payment terms on the loan.

A line of credit allows you to take out more money as needed, so long as your total amount of borrowing is below the established limit. With a signature loan if you would like more money, you have to take out a second loan.

Why Take a Signature Loan?

Signature loans are useful for covering significant, short-term costs. People will often use them to cover costs such as wedding expenses, medical expenses, and short-term bills while waiting for a paycheck.

Some lenders will build specific signature loans around specific products such as medical loans. Regardless of the specific terminology, any loan that is secured by nothing more than a promise of payment is considered a signature loan.

Finally, some borrowers will take out a signature loan to consolidate debt. This can be useful if you have relatively short term, high interest debt. In those cases a signature loan can help you to consolidate payments and potentially reduce interest rates. Just be aware that signature loans tend themselves to be short term and high interest. Many, if not most, forms of borrowing will be ill-equipped for consolidation under this form of lending.