Topics Covered Hide
- Understanding the concept of an unsecured loan
- Becoming familiar with how unsecured loans work
- Which describes an example of using unsecured credit?
- Main differences between secured and unsecured loans
- Benefits of secured loans
- Benefits of unsecured loans
- Alternatives to both secured and unsecured loans
- What to use an unsecured loan for
- How much money you can borrow with an unsecured loans
There are more types of loans out there, and what works for some people will not work for everyone else. Which describes an example of using unsecured credit? What is the benefit of providing collateral? What happens if you fail to repay the loan?
There are so many questions out there, and since each case is individual, there are different answers to each of these questions. This guide will analyze unsecured credit and loans, as well as how you can take advantage of them.
Understanding the concept of an unsecured loanAn unsecured loan is simple to describe – there is no security to back it up. Practically, the lender will not ask you for any type of collateral. You do not have to come up with anything upfront – unless you want to make a down payment first, but it is not necessary.
Collateral can include different things – your personal assets, most importantly. For example, get an auto loan, and the car will become the collateral. Fail to repay the loan and the lender will take the car and sell it to recover the money – simple as that. The same rule applies to any asset you use as collateral.
But since the credit is unsecured, none of these things will happen. Instead, the lender will rely on your creditworthiness. If there is a credit score system where you live, this number will tell the lender whether or not you are a reliable person.
So, which describes an example of using unsecured credit? Take a personal loan, for example. It will not be massive, but it will help with different things, such as a car or perhaps some repairs around your home. It is not backed by any assets.
Student loans go in the same category. You basically get a loan to educate yourself, and you are expected to pay it back as you get a job. It is not backed by any collateral. Credit cards do not require collateral either.
Now, before going for an unsecured loan, it is worth noting that borrowers find such loans to be a bit risky. After all, if you stop paying, there is no asset they can take from you to recover their money. Such loans clearly require a higher credit score if you want to be approved.
For the exact same reason, unsecured loans may come with bad deals. Interest rates are normally a bit higher, so you may end up paying more in the long run. However, the risks on your side are much lower than in secured credit.
What happens to those who default on an unsecured loan? The lender will most likely pass the debt to a collection agency, which will try to recover the money by harassing you. If the debt is too high, the borrower might be taken to court.
Becoming familiar with how unsecured loans workUnsecured loans might be available under more financial names. For example, some lending institutions refer to them as signature loans. Some others give them out as personal loans, although the actual personal loan is just a type of unsecured loan.
Again, such loans are approved without bringing in any collateral or assets. It makes no difference what they are – expensive jewelry, property, cars, or other things. Such things come with specific terms, and they are mostly given based on the credit score.
The credit score does not necessarily have to be perfect, but usually in the good range. However, since this is the most important consideration in the process, the higher the credit score is, the better the deals will be too.
Unsecured loans are the opposite of secured loans. In secured loans, the borrower must provide some sort of asset. Sometimes, the asset is the thing you need the money for. You could get an auto car, and the car becomes the security.
No matter what asset it is, the lender must evaluate it first and ensure it is secure enough to be used as collateral for the loan. Secured loans can go in more directions. A car loan is a secured loan, as well as a mortgage.
Now, what happens if you have no assets to use as collateral and your credit score is just as bad? It does not mean that all your doors are shut. In fact, you still have a few options. If you count yourself in this category, you can come up with a cosigner for the loan.
Finding a cosigner is difficult – most people rely on their partners or perhaps close family members. After all, the cosigner takes over the legal obligation to repay the loan if the borrower cannot repay it. Basically, someone else is responsible for it.
High interest rates are part of the game because there is no security involved. You represent a risk for lenders because there is nothing they can take back. Sure, lenders can take other actions too – such as relying on collection agencies or perhaps taking you to court.
Court cases are quite rare, though. Most lenders deal with collection agencies only. However, if the debt is too high, there is a decent chance of being taken to court. If the court fails to rule in your favor, your wages could be garnished.
Other problems may also arise when you go to court. For example, if you own a home, a lien might be placed on it. A default will have more consequences later on, such as a low credit score, which will affect your further financial decisions.
Which describes an example of using unsecured credit?Unsecured loans are extremely diversified and go in more directions. Most credit cards are unsecured. The same goes for classic student loans. On the same note, personal loans are usually unsecured too – your own bank is more likely to accept you because it is familiar with your financial history.
Unsecured loans also go in two categories – term loans or revolving loans. Revolving loans come with a credit limit. You can spend that, but you would have to repay it before spending it again. Revolving unsecured loans are most associated with personal lines of credit and credit cards.
Term loans adopt a more classic approach. You get a specific amount of money that you need to repay over a particular period of time – end of the story. You will deal with equal monthly installments until the loan is fully repaid – it could be a year or perhaps five years.
Term loans are more commonly associated with secured loans, but this is not a general rule. The thing is, both of them work on the same operating principles. Apart from all these examples, consolidation loans taken to handle debt will often be considered unsecured too.
The unsecured loan market has faced significant growth over the past decade. There are more lending institutions than ever. Apart from classic banks, you also have financial technology firms, which operate exclusively online. Fintechs can give you money within hours, for example.
Then, the past years have also brought in the concept of peer-to-peer lending. This concept is also similar to fintechs. There are mobile or online lenders that require a few documents, run a quick check, and transfer the money straight away if they are happy with it.
It pays off shopping around. Get a personal loan calculator – usually free online – to see how much money you might be able to get based on your score and wages, but also to have an estimate of potential interest rates.
Each lender will give you a completely different offer. With so much variety, you are in charge. All this diversity has also pushed the market forward. Only in the USA the revolving debt reached around $980 billion in 2020.
Main differences between secured and unsecured loansYou read about them, and you try to understand every technical or jargon term, just to make sure you make the best decision for your finances. What is the difference between secured and unsecured loans, then?
Just like the name clearly states, putting up security is the main difference. A secured loan is secured against something you own, be it a car, a property, or other valuable items. On the other hand, the unsecured one comes with no collateral whatsoever.
Moving on, the amount you can actually borrow is another major difference. A secured loan does not pose so much of a risk, so it obviously gives you access to more funds. You can normally get more money if you provide some security.
Lenders will have your asset as a backup plan in case you default, so they can take a bit more risk. If you face difficulties, the lender will grab the asset and sell it in order to recover the money. Unsecured loans? Nothing to take back.
Interest rates are not to be overlooked either. After all, this is why you shop around – you want the best possible deal. This is less likely to happen with an unsecured loan for the exact same reason – the actual risk.
The lender takes a risk when there is no security involved. This risk will cost you more in the long run, meaning unsecured loans come with higher interest rates. The longer you drag the loan, the more you will end up paying.
Finally, if there is one major thing that can make the difference in unsecured loans, that is the credit score. The credit score will help the lender determine whether or not you are serious and trustworthy enough for a loan.
The credit score is based on more things. Higher is better. Pay your bills on time, handle other debt responsibly, and your credit score will go up. Go late on bills and other payments, and it will go down – at this point, the lender will reconsider your options.
Do not get the wrong idea, though – a good credit score is quite important for secured loans too. Lenders do not want your assets – too much hassle, fees, and work involved. They would rather have the money back. However, this score is more important if you are after an unsecured loan.
Benefits of secured loansBoth secured and unsecured loans come with pros and cons, which often depend on the differences between them. This is why certain types of loans are better for some people, while others will do with the opposite alternatives.
When it comes to secured loans, the possibility of borrowing more money is by far the most advantageous one. Secured loans give you access to more funds, whether you want a new car, repair your home, or you face some unexpected expenses. On the other hand, unsecured loans are limited.
An unsecured loan will rarely exceed $25,000.
Secured loans also come with more availability. Basically, most people have access to these loans, even if their credit scores are not perfect. A decent score can get them settled though, as long as they have good collateral.
In other words, secured loans might be the only option to those with a relatively bad credit history. However, do not take it for granted. If you are not that good with your finances, using your home as collateral is a bad idea.
Another major benefit is the possibility to repay the loan over a longer period of time. Secured loans can be longer than unsecured ones. Unsecured loans barely go over a few years, while the secured alternative gives you much more flexibility.
Of course, the longer you drag it, the more you will pay in interest rates.
Benefits of unsecured loansWhile it looks like secured loans are almost perfect, the truth is many more people can do with unsecured loans, especially if they have a good credit history and they are relatively good with organizing their finances.
Flexibility is a serious advantage of this alternative. Unsecured loans will allow you to choose how long you want to repay. Most commonly, you will be able to go for anywhere between a year and five years. Secured loans tend to come with a minimum repayment duration – often set to five years.
Furthermore, unsecured loans allow early repayment without too much hassle. You can basically get out of the loan if you pay everything, and the early exit penalties will be relatively easy to deal with. Secured loans are different and come with many more requirements.
Last, but not least, being able to enjoy a loan without collateral is a plus. You do not want to lose your assets, so this is why you get a loan instead of selling them. Risking your home could get you homeless. The car is just as important, not to mention other assets.
Deciding between secured and unsecured loans – Which option is better?
Choosing between secured and unsecured loans will give you plenty of things to think about, especially if you are not limited by one thing or another, and you have access to both options. Here are a few things to take into consideration before making a final decision.
First of all, double check the interest rate. Obviously, you have to shop around and get more deals, but sit down and analyze each of them. The lower the rate is, the less money you will pay in the long run. This is what keeps costs down.
Generally speaking, secured loans are less risky for lenders, so they come with lower interest rates. If your credit score is great, you might as well find good deals for unsecured loans – without any risks of losing your assets. Consider both options and look at interest rates.
Moreover, you need to keep an eye on affordability. Grab a piece of paper, a pen, and a calculator – yet most lenders will provide online calculators too. Find out how much you are about to pay on a monthly basis. Is it affordable? Do you have enough disposable income to cover it?
Double check everything upfront – count every single expense and leave a bit of room for the unexpected ones. Increasing the repayment duration will make monthly payments more affordable. However, the longer you drag it, the more you will pay – take this aspect into consideration too.
Finally, never overlook the risk of default too. Unexpected situations may arise when least expected. If you think there is a risk of default and find yourself unable to pay, maybe getting a loan may not be the best idea. If you are concerned about it, at least get an unsecured loan, so you avoid potential risks.
However, unsecured loans will also pose some risks to your credit score if you default.
Alternatives to both secured and unsecured loansSometimes, a loan may seem like the only option out there. However, it is not. You do not necessarily need to reach a bank in order to get a loan. In fact, there are quite a few alternatives out there – here are some of them.
Remortgaging solutions are quite handy if you need a large amount of money. For instance, finding a better deal somewhere else could help you free up a bit of cash. Mortgage rates tend to be lower when compared to other types of secured loans.
Downsides? You will have to pay some fees to remortgage – plus, the debt might be extended.
A classic 0% money transfer card is a decent option if you do not need too much money. You can borrow funds without paying interest. You can move funds to your current account, but there are some fees involved – they normally depend on how much money you borrow.
Guarantor loans are worth some attention too. From some points of view, they are similar to secured loans. However, you will need someone who trusts you blindly – such as close family members, partners, or friends. You practically need someone else to become the guarantor on the debt.
This means the person you choose will be responsible for the loan in case you default. Interest rates are quite high for this type of loan. It is more common among those with a poor credit history. Plus, should you default, it can seriously affect personal relationships.
What to use an unsecured loan forYour lender will need to know what you need the money for – they will make a decision based on these things. Since unsecured loans are limited when it comes to the amount of money you can borrow, your options are also limited.
Most people get unsecured loans to purchase a different car, do some home improvement projects, go on holiday, or get married. Sometimes, if you have too many direct debits, an unsecured loan is also good for debt consolidation.
How much money you can borrow with an unsecured loansDifferent lenders will give you different amounts of money, depending on your creditworthiness. If you look like a reliable person and your credit score is great, you will be able to secure more funds. Normally, these loans range between $1,000 and $25,000.
Other individual circumstances that could make the difference include your earnings, outgoings, and current debt as well. If you want more money, you may have to build a good credit score and opt for a secured loan instead.
ConclusionIn the end, which describes an example of using unsecured credit? There are more options out there, and most of them relate to student loans, credit cards, and loans for personal needs. However, no matter how many lenders you get in touch with, you will always get different offers.
This is why you need to sit down and analyze each offer individually – or perhaps get in touch with a reliable broker who can help you make a decision. All in all, unsecured loans are preferred because there is less risk for the borrower, but they can still be dangerous in terms of credit score.