Unsecured Loans: What They Are and How They Work?

Unsecured Loans: What They Are and How They Work?

An unsecured loan is a type of credit supported by the creditworthiness of the borrower, and not the value of the collateral issued. This is because the unsecured loan, also known as personal loan, does not require any collateral. The loan is risky, and the borrower must, therefore, have a high credit rating to receive the approval. When the borrower does not have sufficient credit, the lender can ask for a co-signer to guarantee the loan just in case of a default. An unsecured loan is the direct opposite of a secured loan.

Characteristics of Unsecured Loans

Criteria	Description
Absence of collateral	Unsecured debts do not require collateral. Collateral is an asset that you give the lender when asking for a loan. When you default, the financial institution/lender owns the asset.
High-interest rate	Since the loans do not have any collateral, the lender lacks anything to hold against you. For this reason, the loans are characterized by high-interest rates to limit the applications.
No tax benefits	Unsecured loans lack tax benefits. The accrued interest rate is not tax deductible.
Low loan amounts	The amount that you can qualify for an unsecured loan is usually lower than that of secured loans. This is mainly because these types of loans are risky.
Short payment period	An unsecured loan has a short turn around period.

The Main Types of Unsecured Loans:

Credit Cards

Credit cards are essentially unsecured loans because the credit holder gets the money from a credit card company. This is the same as borrowing since the money is paid back after the purchase.

Payday Loans

The popularity of payday loans has recently been increasing. They are convenient and have a quick approval. They are offered by non-financial institutions and have a high-interest rate.

Equity Credit

This is an unsecured loan offered by financial institutions. While the loan can sometimes be secured when it is accompanied by collateral, it is usually an unsecured loan. A Home Equity Line of Credit is a perfect example.

Cash Advance

Cash advances come in two primary forms: advances based on the credit limit and advances based on the level of income. Just like most unsecured loans, the interest rate for cash advances is usually high. The repayment turnaround is also quick.

Signature Loans

As the name suggests, a signature loan only requires the borrowers’ signature. You need to promise your lender that you will repay the money by using your signature. Credit Unions and some banks give signature loans. The borrower pays the loan back through equal monthly installments.

Student Loans

A student loan is also categorized as an unsecured loan. The amount of interest rate and repayment period varies greatly depending on the specific institution where you get them from. Most student loans do not require a credit history.

Peer-to-Peer Loans

Peer-to-peer loans rely more on an individual than on a business, and this is what makes the loan unsecured. Like the other unsecured loans, these loans have a high-interest rate and fixed rate installments.

Small Business Loans

Generally, small businesses have few assets to use as collateral. For this reason, most financial institutions lend unsecured loans to those businesses. The loans are usually given to the borrowers who have a good credit score, and proven business experience. Depending on where you get them from, the interest rate varies.

Term Loans

Term loans are given out by a financial institution. Both the lender and the borrower agree on the specific amount that the lender receives. The payments can be made on a monthly, weekly, or bi-weekly basis. Term loans have a floating interest rate.

The Pros and Cons of Unsecured Loans

PROS	CONS
Easy application process – the process of getting a personal loan through a bank is very tedious. The case is, however, not the same with the unsecured loans.	Small loan amounts – an unsecured loan is not the best option for you if you are looking for a large amount of money.
You do not lose any property – no collateral is given, as thus you don’t lose a property.	Higher interest rate – lenders charge high interest to justify the risk of giving out a loan without collateral.

Who Gets Unsecured Loans?

These loans are ideal for borrowers who do not have any equity. They are also an excellent choice for people with a great credit report. With a high credit score, you can easily negotiate with the lender concerning the interest rate.

Defaulting an Unsecured Loans

Since the loans do not have the collateral requirement, the lender cannot repossess an asset in case of the borrower’s default. The lender can, however, take other actions such as reporting the incident to a court or using a collection agent.

Make An Informed Choice

Before you finalize the intention of getting an unsecured loan, check your budget first. Deduct your expenses from your income. If you get a negative amount, think twice before you go ahead to get the loan. Also, if you need the loan for an emergency, start making small savings so that you don’t default the credit.