Understanding Unsecured Loans

Whether you need to purchase a new computer for the family room or want to upgrade the carpet in the master bedroom, you may want to consider using an unsecured loan for these purposes. Yet you may want to ensure you understand unsecured loans including the pros and cons behind using them before signing on the dotted line.

What is an unsecured loan?

An unsecured loan is a loan with no collateral backing it up. For example, when you finance a car—if you fail to make your monthly payments, the bank that owns your loan may repossess the car from you as its collateral for the loan in question. An unsecured loan does not have physical possessions backing up the loan process.

Therefore as you might assume, unsecured loans are a riskier investment for lenders. As they cannot seize property to repay the amount owed if you default on the loan, they will have to pursue other options in order to be paid. Due to this risk, lenders typically charge higher interest rates for unsecured loans.

Types of Unsecured Loans

There are numerous types of unsecured loans, but here are a few:

  • Student loans

Most loans used to pay college costs whether it’s for classes, housing or books, are unsecured. However, as the name implies, you must be an active college student to obtain one of these loans.

  • Signature loans

These loans are good-faith loans offered by lenders and typically require your signature and your promise to repay said loans. You will need a steady source of income to obtain a signature loan and will be required to make monthly payments.

  • Personal line of credit

This is another unsecured loan much like a signature loan except you can reuse a personal line of credit as you pay down your debt. For example, if you obtain this loan from your bank for a maximum of $10,000 and repay it with monthly installments, you can borrow up to the limit again.

  • Credit cards

Most people don’t realize that their credit card is another example of an unsecured loan. Credit cards typically have a limit based off your credit score and often have higher interest rates in comparison to other types of loans.

How do I obtain an unsecured loan?

Obtaining an unsecured loan will depend upon the type of loan you are looking for. In regard to student loans, personal lines of credit and signature loans, you should approach your local banks and credit unions to attempt to secure a loan. Credit cards, on the other hand, typically send offers straight to your mailbox or if you cannot wait, you can apply online for your loan directly to various credit card companies.

Please note lenders will consider your credit score, your income, and your ability to repay the loan when deciding whether to offer you an unsecured loan. Expect to pay a higher interest rate if you have poor or bad credit and you may need to approach multiple lenders before finding one that will entrust you with a loan.

What if I miss a payment on an unsecured loan?

You should always read the fine lines when obtaining any loan—secured or unsecured. Most lenders offer a grace period for late payments, but consistently being late may result in penalties such as interest rate hikes, credit decreases or your account closing. If you default on an unsecured loan, lenders may take legal action against you to garnish your wages.

Unsecured credit comes in many forms and may be useful to you in the future. Understanding unsecured credit is essential to your financial future.

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