What Is A Secured Loan?
Debt can be broadly broken up into two categories - secured and unsecured debt. Secured debt refers to any loan in which some form of collateral is pledged in order to guarantee the loan. Should the borrower fail to repay, the lender can repossess or take control of the asset.
With unsecured loans - also referred to as signature loans or personal loans - the loan is not backed by anything other than the borrower's credit history and a promise to repay.
If a borrower defaults on the loan, there is nothing the lender can seize to recoup their losses. Unsecured loans require higher credit scores and usually come with higher interest rates because they pose a higher level of risk for lenders.
There are two main types of unsecured debt: lump-sum loans and revolving lines of credit:
Lump-Sum Loans -
The borrower receives a single lump sum in their account that carries a fixed payback term.
Revolving Line Of Credit -
Here, the borrower is allowed to draw from the credit line as and when needed up to their assigned limit. There is no set payback term and as long as the minimum payment is made the line of credit will stay open.
Unsecured Loan Types
There are several types of unsecured loans, each tailored to a specific situation or need. It is important to know what unsecured loan options are available, the most common of which are listed below.
A consolidation loan is sought out by individuals who have several debt payments to make per month. A loan is taken out which is used to pay off all outstanding debts, leaving the borrower with a single monthly payment to handle.
For those who carry high-interest rate debt, such as credit cards and payday loans, a consolidation loan can be attractive because they usually offer lower interest rates than the previously mentioned forms of debt. Lower interest rates can help people save thousands of dollars in interest payments and result in the debt being paid off faster.
Unlike installment loans, revolving loans have no fixed payment term and can be used as and when needed. This type of unsecured loan operates very similar to a credit card.
A borrower has a set limit they are allowed to spend up to and, as long as the minimum monthly payment is made, the line of credit stays open.
A revolving loan is one of the most useful types of unsecured debt because it offers access to liquid cash that other loan vehicles do not.
Because there is no set payment term, they can be easier to manage than installment loans, which require a set payment every month and often come with prepayment penalties.
One of the most common types of unsecured loans, term loans have a fixed payment schedule and carry either a fixed or variable interest rate.
Those who take out a term loan will have to pay the same amount every month for a predetermined period. Payback periods can range anywhere from a couple of years to over a decade. This type of loan is very common with small businesses that use the loan to purchase equipment, inventory, or other assets.
Unlike a revolving loan it is not meant to provide access to liquid capital, but instead for the purchasing or financing of specific items.
Unsecured Loans And P2P
Peer-to-peer lending, also commonly referred to as P2P loans, take place directly between two individuals without a financial institution involved.
The borrower posts a profile on an online portal that includes the typical information a lender would request before being assigned a risk category.
Once this profile has been set up, prospective borrowers can make loan applications. Lenders can view and submit offers, and the borrower then has the choice to accept or reject offers.
Should they accept an offer, funds will be deposited into their account and the borrower will use the online platform to make monthly repayments. Many people seeking out P2P loans are doing it for the purpose of debt consolidation.
How to Qualify For An Unsecured Loan
After determining the appropriate type of unsecured loan, borrowers should choose a lender and complete the application process. Most application processes are fairly straight forward and will require information such as the current debt load, income level, and occupation. Borrowers will also be required to consent to a hard credit check.
If the lender decides to approve the application, the borrower will have a set time frame, usually a week or two, to review the terms of the loan and either accept or reject the offer.
Rates And Fees
Interest rates vary widely depending on the applicant's credit score and the individual lender. Those with a high credit score can qualify for rates as low as 6.0% (possibly even lower) whereas those with poor credit may end up paying rates as high as 36.0%. The average APR for a 24-month unsecured loan is currently 10.2%, but it is important to keep in mind that rates may fluctuate with market conditions.
Many lenders attach closing fees with loans called origination fees. On average, one can expect to pay origination fees of around 1% of the total loan value, although this can vary depending on the lender.
Defaulting On An Unsecured Loan
Unlike secured loans, should a borrower default on their loan there is nothing the lender can repossess. This being said, the borrower does suffer some negative consequences.
First, they will experience a major hit on their credit score, which could impact their ability to secure any other loan in the future. The lender may also use a collection agency in an attempt to collect on the loan.
In extreme cases, the lender may decide to take legal action against the borrower, which can result in costly legal fees.
Where To Get An Unsecured Loan?
The most common place people go for an unsecured loan is a bank or credit union. These institutions usually offer the best rates and allow applicants to sit down with a qualified loan specialist to discuss their options. Still, banks and credit unions have stricter lending criteria, meaning many people with a lackluster credit score may not qualify.
Another area to explore unsecured loan options include online vendors such as Discover, SoFi, and LightStream. While some online lenders may be more lenient with credit scores, others may be stricter. Shopping around to find the best loan is highly recommended.
Remember, the preapproval process utilizes soft credit checks, meaning applicants can see what loan terms they qualify for without temporarily impacting credit scores.
Over the last decade there has been a sharp rise in people applying for unsecured loans online.
This is likely due to the ease of application, fast approval process, and quick disbursement of funds after approval.
Moreover, as previously mentioned, P2P lending has become a popular avenue for people seeking to consolidate their credit card debt at a lower interest rate. Those seeking unsecured loans may consider identifying available P2P options.
Borrowers seeking personal loans should compare all the options available to determine what type of loan fits their situation and financial circumstances best. Shopping around for the most favorable rates is also a recommended practice given lenders can offer varying rates and terms to the same applicant.