Unsecured loans are types of loans that are not backed up by collateral. It is excellent for those who need funding but are hesitant to risk any of their assets or cannot pledge any asset as collateral.
If a borrower fails to repay the loan, the lender will be left with few options to get repayment. The options include reporting your status to a credit bureau, suing you in court, or referring you to a third-party debt collector.
What is an Unsecured Loan, and How Does it Work?
If you are looking for a funding option that does not risk losing your assets, an unsecured loan might be the right choice for you. Just like any other debt, you will agree on paying back the loan on time. However, that agreement will not be backed up by any collateral.
Since you won’t pledge collateral, lenders look for other ways to make sure you can repay the loan in the long run. You will need a good credit score and sufficient income to qualify. If you currently have a bad credit status, consider rebuilding your credit first. Moreover, it would help for you to know that there are lenders that offer unsecured loans for people with bad credit.
Unsecured Loans vs. Secured Loans
Unsecured loans and secured loans significantly differ in the necessity of collateral. When you apply for a secured loan, you will be required to put up collateral. The collateral can either be any of your assets, such as your car, boat, or house.
Suppose you pledged your car as collateral for a secured loan and failed to make repayments. The lender can repossess your car as a form of payment for the loan you failed to pay. This is possible because you have given the lender the right to do so by putting up your car to secure the loan.
However, that is not the case for an unsecured loan. The lender will not have any right to repossess any of your property as payment for the loan. Hence, you are safe from losing your assets to lenders.
Advantage and Disadvantage of Unsecured Loans
As a borrower, the significant advantage of getting an unsecured loan is not putting your assets at risk. If you fail to repay the loan, your credit score will take the toll and not any of your assets.
Since unsecured loans are riskier from a lender’s point of view, they tend to have higher interest rates, unfavorable terms, and require higher credit scores. Collaterals act as security for lenders, and because they don’t have that in an unsecured loan, they need to think of other ways to gain from the loan or ensure repayment.
Forms of Unsecured Loans
There are three forms of unsecured loans you should know about:
Personal loans are mostly unsecured. They are installment loans, which means that you are given a monthly payment schedule set over multiple years (2 to 7 years depending on the loan) to repay the loan with interest. This can help you manage your budget easily since you know when you have to repay the loan you owe.
This type of loan can be used for almost any purpose, like if you need the money for an emergency such as medical bills or consolidating debts. They are offered by online lenders, credit unions, and banks. Moreover, personal loans can provide you with a lump sum of cash. Hence, it is ideal for big purchases.
Unsecured Credit Cards
Unsecured credit cards are the most common type of credit card. A security deposit is not necessary to get approved for one. This means the issuer doesn’t have any deposit to take if you fail to repay the debt.
Online lenders, credit unions, banks, and other financial institutions offer credit cards. If you get approved for one, you will be able to make purchases in restaurants, stores, online, or over the phone to any establishment that accepts credit cards as payments. However, you have to make sure that you won’t exceed your credit limit and fully pay your debt monthly to avoid expensive interests or penalties.
Types of Unsecured Loans
The forms of unsecured loans stated above can either be a revolving loan or a term loan. Below are the types of unsecured loans:
- Revolving Loan– this type of Loan has a credit limit that you can spend, repay, and spend again.
- Term Loan– this type of loan lets you borrow money to be paid in installments until the end of the loan term.
- Consolidation Loan– this type of loan lets you pay off multiple debts.
If you don’t want to risk losing any of your assets in getting a loan, applying for an unsecured loan is an excellent way to go. It will help if you keep in mind that most unsecured loans come with higher interest rates, fees, unfavorable loan terms, and require good credit scores. However, finding the right lender can help you with that problem. Furthermore, always remember to apply for an unsecured loan you can afford to avoid being stuck with the debt.