Signature loans are loans that involve no collateral. Your signature serves as your guarantee that you intend to repay the debt. Every lender sets its own standards for underwriting signature loans but the absence of collateral means that these loans expose lenders to more risk than other kinds of loans and, as a result, are usually harder to get.
When you submit an application for a signature loan, the loan officer checks your credit report. Banks can use credit reports from Equifax, Experian and TransUnion and the bank can decline the loan if you have adverse information on your credit report. Generally, banks are reluctant to lend money to people whose credit scores are below 620 since scores lower than that are below average and regarded as sub prime scores. The 620 minimum applies to secured loans and most banks only write signature loans to people who have much higher scores than that.
Lenders figure out how much you can afford to borrow by determining your debt-to-income, DTI, level. To calculate your DTI, you must divide your monthly debt payments into your gross income. Typically, lenders do not lend to you if the new loan will cause your DTI ratio to exceed 35 percent. Some lenders impose even lower DTI caps on non-secured loans. However, if you have a very high income level your lender may make an exception based upon the dollar amount of your disposable income.
When lenders price loans, high interest rates are charged on high-risk loans while low-risk borrowers pay the lowest rates. Risk levels are lowest on secured loans, such as home loans, because the lender can recoup its losses by selling the home of a delinquent borrower. However, lenders have limited abilities to collect payments on delinquent signature loans, therefore, these loans usually have very high interest rates. Additionally, lenders limit term times so most signature loans have terms of just a few years. High interest rates and short-term times result in high monthly payments. Consequently, few borrowers who have sufficient income to afford these high payments actually find themselves in need of the loans.
Signature loans involve minimal underwriting when compared with secured loans, but you must provide the lender with a copy of a government-issued form of identification to establish your identity. Most lenders also require you to provide copies of your tax returns and W-2s to verify your income. Signature loans typically have no closing costs unless you live in a state with document tax in which case you may pay a small fee to close the loan. Because of the absence of closing costs, lenders typically do not require you to provide copies of bank statements and your other financial assets.