Definition of unsecured loan
What is an unsecured loan?
An unsecured loan is a loan that does not require any type of collateral. Instead of relying on a borrower’s assets as collateral, lenders approve unsecured loans based on the creditworthiness of the borrower. Examples of unsecured loans include personal loans, student loans, and credit cards.
Key points to remember
- An unsecured loan is only supported by the creditworthiness of the borrower, rather than by any collateral, such as property or other assets.
- Unsecured loans are riskier than secured loans for lenders so they require higher credit scores for approval.
- Examples of unsecured loans are credit cards, student loans, and personal loans.
- If a borrower defaults on an unsecured loan, the lender can mandate a collection agency to collect the debt or sue the borrower.
- Lenders can decide whether or not to approve an unsecured loan based on the creditworthiness of the borrower, but laws protect borrowers from discriminatory lending practices.
How an unsecured loan works
Unsecured loans — sometimes called signature loans Where personal loans-are approved without the use of property or other assets as collateral. The terms of these loans, including approval and receipt, are most often dependent on the credit rating. Generally, borrowers must have a high credit score to be approved for unsecured loans.
An unsecured loan precludes a secured loan, in which a borrower pledges some type of asset as collateral for the loan. The pledged assets increase the “security” of the lender for granting the loan. Examples of secured loans are mortgages and auto loans.
Since unsecured loans require higher credit scores than secured loans, in some cases lenders will allow loan applicants with insufficient credit to provide a co-signer. A co-signer assumes the legal obligation to honor a debt if the borrower default values. This happens when a borrower fails to repay interest and principal on a loan or debt.
Since unsecured loans are not backed by collateral, they are riskier for lenders. As a result, these loans usually come with higher interest rates.
If a borrower defaults on a secured loan, the lender can repossess the collateral to recoup the losses. On the other hand, if a borrower defaults on an unsecured loan, the lender cannot claim any property. But the lender can take other steps, such as assigning a collection agency to collect the debt or suing the borrower. If the court ruled in favor of the lender, the borrower’s salary may be garnished.
Also a privilege may be placed on the borrower’s home (if he owns one), or the borrower may otherwise be ordered to pay the debt. Defaults on payments can have consequences for borrowers, such as lower credit scores.
Types of unsecured loans
A revolving loan is a loan whose credit limit can be spent, paid off, and spent again. Examples of unsecured revolving loans are credit cards and personal loans. Credit lines.
A term loan, on the other hand, is a loan that the borrower repays in equal installments until the loan is repaid at the end of its term. Although these types of loans are often affiliated with secured loans, there are also unsecured term loans. A consolidation loan to pay off credit card debt or a signing loan from a bank would also be considered an unsecured term loan.
In recent years, the unsecured loan market has grown, fueled in part by fintechs (short for FinTech companies). The last decade, for example, has seen the rise of peer-to-peer loan (P2P) through online and mobile lenders.
$ 979.6 billion
The amount of revolving debt of U.S. consumers as of October 2020, according to the Federal Reserve.
If you are looking to take out an unsecured loan to pay for personal expenses, a personal loan calculator is a great tool for determining what the monthly payments and total interest should be for the amount you hope to borrow.
Unsecured loan vs payday loan
Alternative lenders, like payday lenders or companies that offer traders cash advances, do not offer secured loans in the traditional sense. Their loans are not backed by tangible collateral like mortgages and auto loans. However, these lenders take other steps to secure the repayment.
Payday lenders, for example, require borrowers to give them a post-dated check or agree to an automatic withdrawal from their checking accounts to repay the loan. Many online merchant cash advance lenders require the borrower to pay a certain percentage of online sales through a payment processing service such as PayPal. These loans are considered unsecured even though they are partially secured.
Payday loans can be considered abusive loans as they have a reputation for extremely high interest and hidden terms that charge borrowers additional fees. In fact, some states have banned them.
While lenders can decide whether or not to approve an unsecured loan based on your creditworthiness, laws protect borrowers from discriminatory lending practices. The promulgation of the Equal Credit Opportunity Act (ECOA) in 1974, for example, prohibited lenders from using race, color, sex, religion or other factors unrelated to creditworthiness when evaluating a loan application, establishing terms of a loan or any other aspect of a credit transaction.
As lending practices have gradually become more equitable in the United States, discrimination persists. In July 2020, the Consumer Financial Protection Bureau (CFPB), who heads ECOA’s compliance and enforcement oversight, has issued an Information Request for public comment to identify opportunities to improve what the ECOA is doing to ensure unauthorized access. discriminatory to credit. “Clear standards help protect African Americans and other minorities, but the CFPB must support them with measures to ensure that lenders and others obey the law,” said Kathleen L. Kraninger, director of CFPB.