What is a Signature Loan?

A signature loan, also known as a good faith loan or character loan, is a type of personal loan offered by banks and other finance companies that uses only the borrower's signature and promise to pay as collateral. A signature loan can typically be used for any purpose the borrower chooses, although the interest rates may be higher than other forms of credit due to the lack of any real collateral.

How a Signature Loan Works

To determine whether to grant a signature loan, a lender typically looks for a solid credit history and sufficient income to repay the loan. In some cases, the lender may require a co-signer on the loan but the co-signer only signs a promissory note and is only called upon in the event the original lender defaults on his payments.

{Important: Many borrowers with good credit and high income turn to these loans.}

Signature Loans vs. Unsecured Term Loans

Signature loans are a type of unsecured term loan. Unsecured refers to the fact these loans are not secured by collateral like home mortgages and car loans. Term means the loan is paid off in a set period of time, usually in equal monthly installments throughout the term. The account is considered closed once a signature loan is repaid and, if the borrower wants to spend more funds, he needs to apply for a new loan. In contrast, if he had a revolving account such as a credit card or a line of credit, he could repay the loan and spend the money repeatedly until he or the lender closes the line of credit.

How Do Businesses Use Signature Loans?

Borrowers use signature loans for a range of purposes including home improvements, unexpected expenses, medical bills and vacations, as well as other large expenditures. Some borrowers also use signature loans to consolidate other debts.

For example, a borrower gets a signature loan with a 7% interest rate and balances on his credit cards have a higher rate. In this scenario, he may decide to use the signature loan to pay off his credit cards. Then, as he repays the signature loan, he ends up spending less on interest and saves money in the long run.

Signature Loan vs. Revolving Credit Line

A regular credit or revolving credit loan application normally triggers a funding delay while the banking institution or loan company examines the borrower's credit history and checks personal qualifications. Alternatively, the funds obtained through signature loans get deposited in the borrower's account more quickly, allowing earlier allocation.

How Have Signature Loans Changed Over the Years?

While the purpose and structure of signature loans has not changed over the years, many financial analysts claim the profile of the average borrower accessing signature loans has changed. In the past, borrowers with poor credit scores tended to take out signature loans, but as interest rates have fallen and loan maximums have increased, many borrowers with good credit and high income have also turned to these loans.