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 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: The interest rate on a signature loan may be higher than other forms of credit due to the lack of collateral.]

Signature Loan vs. Revolving Credit

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. By contrast, the funds obtained through signature loans are deposited in the borrower's account more quickly, allowing earlier allocation to financial needs.

Signature loans are one type of unsecured term loan. Unsecured refers to the fact these loans are not secured by any form of physical collateral, unlike home mortgages and car loans. Term means the loan is amortized over a predetermined time period and paid off in equal monthly installments.

The account is closed as soon as a signature loan is paid off and the borrower needs to apply for a new loan if they require additional funds. In contrast, a revolving credit account allows the indebted party to repay the loan and maintain the line of credit until borrower or lender chooses to end the relationship and close the account.

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; meantime, balances on the borrower's credit cards carry higher interest rates. In this scenario, the borrower may decide to use the signature loan to pay off their credit cards. Then, as they repay the signature loan, they end up spending less on interest and save money in the long run.

How Have Signature Loans Changed Over the Years?

While the purpose and structure of signature loans have not changed over the years, financial analysts report that 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.