An unsecured loan is essentially money that is lent to you from an organization without the need for collateral in order to secure repayment. Typically, these kinds of loans are considered relatively high-risk, because the lender doesn’t normally have a way of forcing the borrower of the loan to fulfill the loan’s terms or make timely payments except through legal action. And so, most unsecured loans are typically only available to people with good credit scores and carry comparatively high-interest rates as well.
Why People Pursue Unsecured Loans
Unsecured loans are mostly used for smaller, short-term expenses such as a wedding, funeral, or an unexpected medical emergency. Most often, they are meant to be repaid in less than a year though some terms vary based on the size of the loan, along with the relationship between the borrower and the lender. For example, if you're a long-time customer of a bank, they may be more likely to offer flexible loan terms.
Another reason someone may try to get an unsecured loan is simplicity. When it's only for relatively small amounts of money, it’s usually not worth the hassle of procuring collateral or transferring property titles. Often, a simple contract is the best way to go about it, even if there are a few concessions.
Getting a Bank Loan
Customers of a bank generally apply for an unsecured loan as a way to obtain cash quickly. Unlike a car or home loan, unsecured loans are given without collateral. There are contracts and papers to sign and process, but the bank will not seize any of the borrower’s property if they fail to repay the loan. This is called a signature loan.
However, a bank will not provide an unsecured loan to just anyone. A candidate must have a steady income in addition to a history of making timely payments and a high credit score.
Credit Card Transactions
Credit card purchases are most often structured as an unsecured loan. Credit card companies provide a set limit, or line of credit, to the borrower and are only secured by their agreement to repay the purchases. Failure to repay may result in higher interest rates and fees, but not seizing any property. Only as a result of a court order is property actually seized – generally issued to remedy ongoing failure to repay.
Unsecured Personal Loans
The majority of loans that occur between friends and family members are unsecured. They are often informal and are most likely not documented in writing. Both parties will often settle on a verbal agreement about the specific terms but is rarely enforceable.
Interest Rates
One key characteristic of nearly any unsecured loan is high-interest rates. Lenders can protect themselves against loan default by charging higher than average lending rates. Quite often, banks offer stronger competitive interest rates than standard credit card companies, but only sometimes. Savvy borrowers must carefully examine every angle of the terms prior to committing to a particular loan.
Tax Considerations
Any individual carrying a secured loan such as a home loan can generally deduct the interest charged on their income tax return. However, this is mostly unheard of relative to an unsecured loan, at least in the U.S.
