What are Unsecured Loans?

While the name may sound intimidating, unsecured loans are a common form of borrowing. They encompass different types of debt, from credit cards to student loans, all with one main characteristic: they are not guaranteed by physical assets.

To get an unsecured loan, you don’t need to put any collateral like a car or home on loan. This is where it differs from a secured loan, where the borrower pledges an asset as collateral. With an unsecured loan, there is no asset that the lender can confiscate if you stop paying; Only your creditworthiness decides whether and under what conditions you will receive the loan.

The different types of unsecured loans

Unsecured loans are riskier for a lender because if the borrower defaults, there is nothing left to seize. Because of this, unsecured loans tend to have higher interest rates than secured loans.

The types of unsecured loans include:

  • Personal loans, which are paid out as a lump sum and have to be repaid over a certain period of time; Lenders have no control over how you spend the money. While the interest rates are higher on personal loans than secured ones, they are much lower than credit cards. According to the Federal Reserve, the average personal loan rate for the second quarter of 2020 was 9.50%, with you might get a lower rate depending on your credit rating. The average interest rate on credit cards was 15.78%.
  • Debt Consolidation Loans, This is a way to combine various other debts – usually unsecured – in one place so that you only have to make one monthly payment, usually at a lower annual percentage (the actual cost of paying back the loan). Note that there are secured debt consolidation loans as well.
  • Student loans, which usually have lower interest rates than personal loans. Their use is subject to special terms and conditions different from those of a personal loan. Student loans can be obtained from both the federal government and private lenders.
  • Credit cards, This is a form of unsecured debt that gives you unlimited access to a certain amount of credit, as long as you meet your repayment obligations.

Unsecured loans are usually for smaller amounts compared to secured loans. For example, the average unsecured personal loan balance is $ 8,500, according to data collected by the St. Louis Federal Reserve.

The proliferation of financial technology or “fintech” companies, which include many online-only lenders, has fueled rapid growth in the unsecured loan market, largely through a surge in personal loans. There were 38.4 million personal loan accounts in the US in 2019, up 11% from the previous year. Due to the quick and easy application processes offered by many online lenders, fintech companies generated nearly 40 percent of all unsecured personal loans in 2018, according to an estimate by credit monitoring company TransUnion.

When an unsecured loan makes sense

Unsecured loans “are available to almost anyone with decent credit, regardless of what they own,” said Nishank Khanna, chief financial officer of New York-based online lender Clarify Capital.

Pro tip

Speak to your lender personally. You can access loans entirely online, but you may get a better deal if you have a face-to-face meeting.

You can get an unsecured loan from a variety of sources such as: Peer lenders and other non-banks, as well as fintech lenders.

Big banks are currently slashing unsecured lending, says finance attorney Leslie H. Tayne, author of Life & Debt and founder and CEO of Tayne Law Group in New York. Because they assess risk in the face of the economic uncertainty caused by the coronavirus pandemic, they often find unsecured loans too risky for everyone but the most skilled borrowers.

If you have poor credit, an unsecured loan from any of the above lenders would have a relatively high interest rate – but unlike credit cards, it would remain fixed for the life of the loan. In the case of unsecured loans, processing fees also apply, which can amount to 1 to 5% of the loan amount.

You should also consider why you want to apply for the loan. If you simply don’t want to fund essential expenses that you don’t currently have the money for, borrowing like this may not be a good idea: “If you can’t live, a personal loan can only be a temporary interruption. Gap Measure, ”said Joseph Toms, President and CEO of Freedom Financial Asset Management in San Mateo, California.

If you default on an unsecured loan, that is, you fail to make your monthly payment for a period of 30 to 90 days, your loan may be forfeited. This can dramatically affect your creditworthiness for up to seven years, says Jonathan Howard, a financial advisor at SeaCure Advisors in Lexington, Kentucky. It can also lead to a lawsuit in which the collector attempts to secure repayment – including fees and accrued interest – through garnishment of wages. There may even be a result that contradicts the original nature of an unsecured loan: the creditor can mortgage your personal property.

Advantages and disadvantages of unsecured loans

advantages

  • No collateral required
  • Can help you consolidate high interest debt on better terms
  • Personal loans often have fixed terms so you can schedule and schedule regular monthly payments

disadvantage

  • Can incur high interest rates and fees
  • Often need a very good or excellent credit rating, especially with good credit terms
  • Depending on your creditworthiness, you may be granted a lower loan amount than a secured loan

Obtaining approval for an unsecured loan

You are more likely to be eligible for an unsecured loan with a credit rating of at least 600, but ratings of 700 guarantee you a better interest rate.

In addition to your creditworthiness, you should also know your debt-to-income ratio.

“Ideally, your monthly debt payments shouldn’t exceed 15% of your normal take-home salary,” says Howard, making sure your total consumer debt doesn’t exceed that number. ”

While applying for an unsecured loan online is quick and easy, Tayne is an advocate of having a face-to-face meeting with a lender, such as a local bank or credit union, when looking for unsecured loans. In addition to offering a more personalized service, they may offer lower interest rates, especially if you have a low credit score. more flexible conditions; and smaller loan amounts.

Once you have a shortlist of potential lenders, Howard recommends getting pre-approved, which just requires a gentle credit check – that won’t affect your creditworthiness – so you can compare interest rates and know the size of the loan you’re being approved for. Toms also suggests asking if the lender offers discounts, especially if you are applying to a co-borrower who can offer additional income guarantees or if you have retirement plans.

Make sure you understand the terms of the loan, such as: B. the interest rate, any application fees or upfront costs, whether there are penalties for early repayment of the principal and what payment terms apply. With unsecured loans, it’s especially important to understand what happens if you default, says Tayne.

The lender will also do a tough credit check for that will Affect your creditworthiness before approving or rejecting the application. You’ll need to show your Social Security number, government-issued ID, and most likely proof of income. Depending on the lender, you may also be asked to open an account of all outstanding debt and your professional history. In order to receive the funds, you will need to provide your bank account details for the deposit. Once the loan expires, it can take up to a week for the money to arrive, says Howard.

Bottom line

People who want to borrow money in a lump sum with no collateral have a multitude of options. If you have good credit and want to repay the money in the short term, an unsecured loan may be the right option for you. Look for the best interest rates – but don’t let the simplicity of applying for a loan online make you borrow money this way if you are unable to do it.

further reading

We have written extensively on credit, including personal credit, and debt management. Below you will find some highlights of our reporting so far.

Personal Loans

  • Best personal loan rates
  • Everything you should know before getting a personal loan
  • A personal loan can be useful 3 times and definitely not 3 times
  • How to get a personal loan
  • Know your options before deciding where to get a personal loan
  • Can you get a personal loan with bad credit or no credit or when you are unemployed?
  • Never accept your first loan offer and 5 more tips

Debt management

  • Everything you need to know in order to choose the right debt consolidation strategy
  • Could a Credit Advisor Help You Get Out of Debt?
  • This strategy could be your secret weapon for getting out of debt