What are Unsecured Loans
Unsecured loans are a type of debt that is obtained from a financial institution without being collateralized by a lien on the borrower’s assets, protecting the creditor against liquidation or bankruptcy. If the borrower defaults on his/ her financial obligations, the creditor has a general claim on the assets, but only after pledged assets are taken by the secured creditors.
Unsecured loans are also referred to as personal loans and signature loans. They are used by the average borrower for making small purchases such as vacations, home improvements, computers, and unexpected expenses.
With these loans, the creditor relies on the promise of the borrower to pay the money back. Obviously, lenders take bigger risks by granting unsecured loans, compared to secured ones, and the interest rate will be higher. The borrower normally makes set payments over a predetermined period of time, and penalties apply if the loan is paid off earlier. In general, unsecured loans are less flexible and more expensive than the secured type. They are a good borrowing instrument if you plan to apply for a short term loan (between 1 and 5 years).
Purchases charged to a credit card are also considered a type of an unsecured loan. Every time a customer makes a purchase on his/ her credit card, they sign a form that authorizes the payment. This represents an agreement to pay off the borrowed amount. Whenever a person obtains a credit card, the size of the loaned money and the terms of repayment are predetermined.
In other words, the card is a form of agreement to the terms and conditions the credit card issuer has set. The money is not obtained against collateral such a property ownership or a home. The issuer has only the agreement of the borrower to pay back the borrowed amount. If the loan is not paid off in a timely manner, additional fees may apply and the account can be sent to collections. In this case, legal proceedings against the borrower may follow.
In case the borrower experiences a considerable reduction of his income and cannot pay off the loan, he may file for bankruptcy and stop collection. In the majority of cases, the credit card issuers cannot force borrowers to sell assets as to repay the loan once they claim bankruptcy. On the other hand, filing for bankruptcy does a serious damage to one’s credit ratings and in the future, most banks will be unwilling to extend an unsecured loan.
Before granting an unsecured loan, banks and credit card issuers evaluate the creditworthiness of borrowers. Those with a lower credit score are less likely to obtain such loan. Even if the creditor agrees to extend a loan, the interest rate may be higher as the lender takes more risk. If your credit rating is good, it is best to shop around for better interest rates. In many cases, the credit unions offer unsecured loans with the best rates. If the borrower has an account with any of the credit unions, obtaining a loan from them will not be difficult.
To apply for unsecured loans in the USA, credit issuers normally require that you are a legal US resident with a valid Social Security Number and are at least 18 years old. You should have been employed on your current position for at least six months and bankruptcy should be discharged.