Any time you apply for a loan, the lender will review the loan request to determine its overall risk. You may think that risk is entirely determined by your credit rating, but this is not the full picture. Regardless of how great your credit scores are, there is always a risk that you may default on the loan. If you default on the loan, the lender stands to lose a considerable amount of money. One of the ways a lender moderates this risk is through the requirement of collateral. As you explore loan options available, you will find that some loans are unsecured, and other loans are secured. By asking what is an unsecured loan, you can more easily determine which type of loan you should apply for.
The Concept of an Unsecured Loan
Asking what is an unsecured loan is the first step to take before you apply for a loan. An unsecured loan is any type of personal loan that does not use collateral. For example, two common types of secured loans are auto loans and mortgages. An auto loan is usually secured by a car, and a home mortgage loan is secured by real estate. With an unsecured loan, on the other hand, there is no collateral. This means that the lender is typically taking on more risk with an unsecured loan. The lender exposes himself to potential loss without any collateral to offset that loss.
If you are looking at financing options and asking what is an unsecured loan, you may notice that there are some key differences between secured and unsecured loans. For example, most secured loans have a fixed term, but an unsecured loan may have a fixed or revolving term. In addition, loan amounts, loan fees and credit score requirements may be different in comparison to secured financing options.
Deciding on applying for a secured or unsecured loan to meet your current financial needs, you should first ask yourself if you have collateral to link to your loan. Additionally, you should think if you want to put this collateral at risk. Now that you know more about what is an unsecured loan, you can see that linking the collateral to a secured loan means that the lender could potentially seize the asset. The lender does not have this option with an unsecured loan. However, with an unsecured loan, the lender may pursue your other financial assets if you fail to make payments as agreed.
Bonus read – What Is Debtor-in-possession Financing?
Advantages of Disadvantages of an Unsecured Loan
At first glance, the differences between secured and unsecured loans seem minimal. The only real difference seems to be the presence of collateral. However, when you ask what is an unsecured loan, you may be surprised to learn how many advantages and disadvantages you are exposed to when you apply for this type of loan.
Advantages of an Unsecured Loan
As you learn more about what is an unsecured loan, you will be pleased to discover that there are several advantages associated with applying for unsecured financing.
1. The lender does not have to appraise or analyze collateral
This can save you money on related loan fees. It also may result in a faster overall underwriting and loan process. In fact, it could save hundreds of dollars or more in fees. It could also shave at least two to three weeks off of your loan timeline.
2. You will not lose your collateral with an unsecured loan
Another great advantage associated with applying for an unsecured loan is that you do not have to worry about your collateral being foreclosed on if you fall on hard times. For example, while you could refinance your paid off vehicle right now to obtain much-needed cash, defaulting on that new car loan at a later date means that the lender could repossess the vehicle at some point. If you obtain the necessary cash you need from an unsecured loan, on the other hand, the lender will not be able to seize your vehicle.
3. You take on less risk
Some people do not have assets that they can use for this type of loan. Even if you do have an asset that has substantial equity in it or if you plan to buy an asset with the loan funds, you may not want to place that item at risk. An unsecured loan allows you to personally mitigate your risk associated with taking out a loan. The lender takes on more of the risk, in this case.
Disadvantages of an Unsecured Loan
When you ask what is an unsecured loan, you will also learn that there are several disadvantages associated with this type of financing.
1. An unsecured loan exposes the lender to greater risk
To account for this, the lender typically will issue a higher interest rate on the loan in comparison to a secured loan option. The loan term may also be shorter. Because of the combination of these factors, you often will find that the monthly loan payment for unsecured financing is higher.
2. There are several conditions
With an unsecured loan, the loan amount will be limited by the lender’s maximum amount as well as by your personal financial situation. While personal finances fall under review with a secured loan as well. A secured loan may have a higher loan amount. The amount is based in large part on the value of the asset that is being secured. If you need a higher loan amount, it may be necessary to secure the loan with collateral that has an appropriate amount of equity in it.
3. The lender may have stricter requirements
In addition, the lender may scrutinize your personal finances more closely. He could also have some requirements regarding your liquid assets and credit scores. Applicants who are not financially strong may have trouble qualifying for a decent loan amount and interest rate on an unsecured loan.
The lender usually has personal financial requirements with an unsecured loan as well. However, the ratios and limits for an unsecured loan may be tighter. In addition, if you have a lower credit score or blemishes on your credit history, your best option may be to apply for a secured loan rather than an unsecured loan.
There are both positive and negative factors to consider when trying to decide which type of loan to apply for. Now that you are aware of what is an unsecured loan, you can determine if you have collateral. You can use it for your loan request and if you want to place it at risk through your loan. While there are positive and negative factors to consider, you will need to carefully review the options. Do this to determine the right course of action based on your unique circumstances.