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Unsecured Loans

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Unsecured loans are a viable option for borrowers who don't own a house or other property that can be used as collateral on a debt. They are also known as "signature loans" because they depend solely on the good credit history of the borrower - hence the loan is secured not by property or some asset, but simply by a persons signature of a promise to pay.

What is an Unsecured Loan?

A secured loan relies on a piece of collateral - a house, a car, or other valuable item - that a bank or lender is entitled to repossess if a borrower does not repay a loan. This makes secured loans safer for lenders, so they're relatively easy to procure if you have some form of collateral to offer. An unsecured loan, on the other hand, does not have any collateral as a guarantee. Repayment relies solely on the word of the borrower.

Unsecured loans are more difficult to get approved than a secured loan because they present a significant risk for banks and other lenders. When evaluating an application for an unsecured loan, a lender will closely examine your credit rating, income, and financial history before authorizing the advance of the funds.

Types of Unsecured Loans

There are several types of unsecured loans available from most lenders:

  • Personal loan: An individual is solely responsible for repayment
  • Business loan: A business is responsible for repaying the loan
  • Business loan with a personal guarantee: A business is the official borrower, but an individual is responsible to repay the loan if the business defaults
  • Lines of credit: A loan account that can be drawn on as needed, and usually requires only interest to be paid until the loan is due in full
  • Student loan: Offered to college and university students; most student loans do not accrue interest or require any repayment until after the student graduates
  • Credit card: Every purchase on a credit card is an unsecured loan issued by the credit card company
  • Private loan: Borrowing money from family or friends

Advantages and Disadvantages

Unsecured loans have both pros and cons. For a young student seeking higher education or a startup business looking to rent an office and purchase inventory, an unsecured loan may be the only option available. This type of loan, however, can come at a steep price.

Typically, unsecured loans have higher interest rates than secured loans, and they're almost always more difficult to get. Even a small unsecured loan requires a credit check, proof of income, and sometimes references or a co-signer. If your credit score is low or you have negative marks on your credit history, a bank or lender may decline your application. Even if you do find a lender who is willing the loan the money despite negative credit, you'll most likely have to pay a higher interest rate to compensate for the added risk.

Who uses Unsecured Loans

Unsecured loans are an option for anyone who needs money and does not have property to offer as collateral on a secured loan. It's common for people to seek an unsecured loan in order to:

  • Pay for college tuition
  • Pay medical bills
  • Finance a vacation
  • Consolidate several debts into one monthly payment at a lower interest rate
  • Make major home purchases or repairs
  • Start a new business

Unsecured loans are one of the most expensive ways to borrow money, but they can be effective and prudent if considered carefully and paid back faithfully.