A signature loan – or good faith loan – is a form of personal loan offered by financial institutions, like banks, that do not require collateral and only a borrower’s signature. The borrower chooses the purpose of the loan, and the interest rates can be higher due to the absence of collateral.
A signature loan includes a borrower’s signature, which reflects a promise to settle the debt. A thorough credit check and qualification of a potential borrower are conducted before a signature loan is given.
Signature loans are considered unsecured loans, as the borrower does not provide collateral.
Borrowers with excellent credit can receive a lower interest rate on a signature compared to other loans provided by financial institutions.
Understanding Signature Loans
To grant a signature loan, a lender must look for borrowers with good credit history and strong stable income to repay the loan. In a few instances, the lender may ask the borrower to have the signature of a witness or a co-signer on the loan in case the borrower defaults on the loan payment.
Signature loans are considered unsecured loans, as the loans are not backed by collateral, unlike car and home loans.
Examples of Signature Loans
Over the years, the structure and purpose of signature loans have not changed. According to reports created by financial analysts, the profile of the average borrower accessing signature loans has changed. In previous years, borrowers with poor credit scores took out signature loans due to a lack of options.
However, as interest rates on signature loans have reduced and loan maximums have increased, borrowers with good credit scores and high net worth have chosen to apply for signature loans. Individuals with a low credit score can apply for signature loans by adding a co-signer to the documents.
Signature loans are used for various purposes like home improvements, medical bills, vacations, unexpected expenses, and other large expenditures. The loans can also be used to consolidate other debts.
For example, a borrower received a signature loan with a 5% interest rate for an amount that equals the total debt on all their credit cards, with rates ranging from 10% to 15%. The borrower will use the signature loan to pay off their credit card debt in full. The borrower will, in turn, save money, as they will be paying off the 5% rather than the former higher rates.
Revolving credit – or a credit limit – is a form of loan that gives a borrower access to a set amount of money up to a specific credit limit. At the end of the loan period, the borrower needs to pay the initial amount plus the interest owed.
The unique aspect of revolving credit is the borrower’s ability to make minimum payments and carry – or “revolve” – the remaining debt to the next billing period; however, the borrower will need to pay interest on the remaining amount. Revolving credit can be used to manage the borrower’s monthly finances and cover any emergency expenses.
Signature Loan vs. Revolving Credit
The major difference between a signature loan and revolving credit is a funding delay when a potential borrower applies for revolving credit. The financial institution will examine the borrower’s credit score and will undertake a complete assessment of their personal qualifications.
On the other hand, the funds obtained from a signature loan will be deposited in the borrower’s account more quickly than revolving credit, giving the borrower the ability to allocate funds sooner for financial needs.
Also, as soon as a signature loan is paid off, the account is closed. To get additional funds, the borrower must apply for a new loan. For a revolving credit account, the obligated party can repay the loan and keep the credit line open until the lender or the borrower ends the relationship.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: