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 only requires the borrower’s signature and a 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 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 is only called upon in the event the original lender defaults on payments.
- A signature loan uses the borrower’s signature and promises to pay as the sole collateral for receiving the loan.
- Interest rates on signature loans are generally higher than other forms of credit due to the lack of collateral.
- Lenders grant signature loans if they deem the borrower has enough income and good credit history.
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.
Signature Loan vs. Revolving Credit
Applications for regular credit or revolving credit loans normally trigger 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.
As soon as a signature loan is paid off, the account is closed, 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 the borrower or lender chooses to end the relationship and close the account.
Examples of Signature Loans
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.
Adding a co-signer on a signature loan may help a borrower with a minimal credit history or a low income.
These borrowers use signature loans for a range of purposes, including home improvements, unexpected expenses, medical bills, vacations, and other large expenditures. Some borrowers also use signature loans to consolidate other debts.
Let's say a borrower gets a signature loan with a 7% interest rate for an amount equal to the total of balances that they are carry on credit cards, with rates ranging from 12% to 20%. The borrower then uses the signature loan to pay off the credit cards in full. The borrower will realize distinct savings by repaying the same amount of money at 7% rather than at the former higher rates.