The Risks of a Signature Loan

A signature loan is an unsecured loan where your signature is used in lieu of collateral in order to secure your financing. Signature loans provide the benefit of funding without risking loss of an asset. These loans are typically given based on your credit history and debt-to-asset ratio. If you have less than perfect credit, however, there are many lenders who specialize in high-risk signature loans. Anytime you seek an unsecured loan, though, there will be many risks that can outweigh the rewards.

High Interest Rates

The number one risk with an unsecured loan is high interest rates. Unsecured loans are more risky for the lender, and the borrower will pay the price as a result. Using collateral would make the loan safer for the lender and less expensive for the borrower. To secure better interest rates without using collateral, consider boosting your credit score by using a cosigner. A cosigner with good credit can "lend" you their credit to get a lower rate. You may also consider shortening the loan terms. When you shorten the loan terms, you will likely get a lower interest rate, but you will have to pay higher monthly payments. This is only an option if your income is high enough to cover the monthly payments. 

Bad Terms

There are many details to a loan beyond the annual percentage rate. These details include your ability to refinance the loan, pay it off early, or flexibility in your monthly payments. High-risk loans like signature loans often come with unfavorable loan terms. This means you will see high penalties if you attempt to refinance or pay off the loan early. You may also see your debt go to collections within a very short period of time if you miss a payment. Interest rates on high-risk loans may also adjust, so ensure your terms stipulate a fixed-rate if you elect a signature loan.

Magnified Credit Affects

Whether you pay off your loan on time or default on your loan, the results of a signature loan will be magnified on your credit score. Paying off a high-risk, unsecured loan on time without missing a payment will drastically increase your credit score. Getting into too much debt or missing payments on this risky loan, though, will be detrimental. Only take a signature loan if your income is high enough to guarantee payments. Ensure you have emergency funds in case you lose your income for unforeseen reasons or have other unexpected expenses. 

Bankruptcy

When you default on a secured loan, the asset you placed as collateral will be seized. This is scary to some people. In contrast, when you fail to pay off a signature loan, you may face a much scarier circumstance: bankruptcy. Defaulting on a loan when you do not have the liquidity to pay off the lender may require drastic measures. Of course, you can attempt loan consolidation, negotiation or other methods first. However, if you are simply in too much debt, bankruptcy will be the only option. 


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