The short version
- An unsecured personal loan needs no asset as security, so your car or home isn't at risk.
- Rates are usually higher than secured loans, because the lender takes more risk.
- Compare the comparison rate, the fees, and whether you can repay early without a fee.
How an unsecured personal loan works
You borrow a set amount and repay it, with interest, over a set term, usually one to seven years. People use them for a wedding, a holiday, study, renovations, or sudden costs like urgent repairs or medical bills.
Nothing you own is used as security, so the lender can't take back your car or anything else if you fall behind, though it can still take legal action to recover the debt.
Unsecured or secured?
A secured loan is backed by an asset, such as the car you're buying, which the lender can repossess if you don't repay. Car loans and home loans are the most common examples.
An unsecured loan has no such backing, so the lender carries more risk. That's why unsecured loans usually have higher rates and lower limits, and why lenders look harder at your income and credit history. Your credit report shows how you've handled credit before, such as whether you've paid on time, so check it before you apply.
Types of unsecured credit
- Term loans, the usual personal loan: a set amount repaid in equal instalments over a set term.
- Revolving credit, such as a credit card or line of credit: you have a limit, borrow what you need when you need it, and repay on an agreed schedule.
- Debt consolidation loans, which roll several debts into one loan with one rate, one repayment and one lender.
What it costs
Look at the comparison rate as well as the interest rate. The comparison rate adds the lender's standard fees to the interest rate for an example loan, so it shows the cost of two loans on the same footing.
Fees to check before you apply:
- An establishment fee, charged once when the loan is set up. Some lenders charge none; others charge several hundred dollars.
- A monthly or yearly account fee. Many loans have none, but $10 a month adds $600 over five years.
- Late payment fees, usually a flat amount each time. A direct debit set up for payday helps you avoid them.
- An early repayment or break fee, mostly on fixed rate loans, if you pay the loan off early or make extra repayments.
Features worth having
Beyond the rate, these can make a loan easier to live with:
- Weekly or fortnightly repayments that line up with your pay.
- Free extra repayments, so you can clear the loan sooner and pay less interest.
- A redraw facility, so you can take back extra repayments if you need them.
Pros
- Nothing at stake. The lender can't take a car or other asset if you fall behind, though it can still pursue the debt.
- Use it for almost anything. Lenders don't need to value a car or check what you're buying.
- Quicker approval. With no asset to check, many lenders decide within a day.
Cons
- Higher rates. Unsecured loans usually cost more than secured loans for the same amount.
- Lower limits. Many lenders cap unsecured loans lower than secured ones.
- Your rate depends on you. Most lenders set it from your credit history, so you won't know it until you get a quote.
Alternatives
- A secured personal loan. If you're buying a car or have one to offer as security, the rate is usually lower.
- A low rate or interest free credit card. For a smaller amount you can repay within a year or so, a card's interest free period can cost less. Pay it off before the period ends, as the rate afterwards is usually higher.
- Saving first. If the cost can wait a few months, saving for it costs nothing in interest, and a high interest savings account pays you instead.
How to apply
Applying for an unsecured personal loan usually takes 15 minutes online. Most lenders give a decision within a day or two, and some within the hour.
- Check your rate first. Many lenders show the rate you'd get with a soft check, which doesn't show as a credit enquiry, before you formally apply.
- Have your details ready. Lenders ask for ID, payslips or tax returns, your spending, and the debts and credit limits you already have.
- Apply to one lender at a time. Each formal application is recorded on your credit report, and several close together can make lenders more cautious.
- Read the contract before you sign. Check the comparison rate, every fee, and what happens if you repay early or miss a repayment.