Personal Loans Basics: Unsecured Personal Loans

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There are two types of loans – secured and unsecured. We discuss secured personal loans here.

People who have collateral will usually apply for loans “secured” by that collateral. Collateral consists of an item of value, such as a home, car or even a life insurance policy – that the lender can acquire if the loan recipient defaults on the loan.

An individual who needs a loan but has no collateral – someone living in an apartment who takes a bus to work every day, for example – can apply for an unsecured loan.

Because this individual has no collateral, the lender – whether a bank, savings & loan or other agency – will usually require three things from the borrower:

  1. An excellent credit rating. If the borrower has a bad credit rating, a co-signer with a good credit rating can help acquire the loan
  2. A much higher interest rate (compared to that of a secured loan)
  3. A shorter length of time for repayment – anywhere from 2 to 5 years

Related: 15 Ways to Improve Your Credit Score

Personal loans have been growing in popularity in the last few decades. They are used for any number of reasons – to consolidate one’s credit card debt, to pay unexpected medical bills, to make needed home improvements, or even by an entrepreneur to start his or her own business.

The vast majority of people who take out personal loans pay them back. According to Forbes Magazine, only 3.5% of borrowers default on these kinds of loans. This is very likely because personal loans are much smaller than “secured” loans. The average debt for someone with an unsecured loan, in the first quarter of 2018 at any rate, was $7,986. 

Credit bureau TransUnion keeps track of such data as country wide outstanding personal loan balances. For all Americans during the first quarter of 2018, the amount of personal loan balances was $120 billion.

There are many reasons for the growth in popularity of unsecured loans, not the least of which is the ease of borrowing from online lenders. Fintech (financial technology) is a booming business. In 2017, 36% of borrowers turned to online lenders for funds. Compare that to 2010, when only 1% did so!

The most often stated reason from borrowers for requesting a personal loan is to pay off outstanding credit card balances. When an individual has aggregate credit card balances of $7,000 or more, paying 20% interest or even more, consolidating all those cards into a single personal loan with 7% interest is extremely attractive!

So, what are the pros and cons of Unsecured Loans?

The Pros of Unsecured Personal Loans

Quick process

Thanks to the power of the internet, it’s possible to obtain a loan quickly. If the loan takes place over the internet, the money can be in the borrower’s bank account within 24-48 hours.

Interest rate does not change

The borrower is locked into a low interest rate. Contrast that with moving credit card debt from one card to another that offers a balance transfer plan. The user receives typically 12 months interest free, but after that the interest on the amount can jump up higher than 20%.

Assets are still available if needed

Money placed into many retirement accounts is required to stay there for a fixed period of time. Early withdrawal, in order to pay unexpected bills, for example, will result in penalty fees and taxes. An Unsecured Loan alleviates this problem – but if the borrower is having problems repaying the loan, this money can be drawn upon.

Bankruptcy

If necessary, and as a last resort, someone with a great amount of unsecured loan debt can declare bankruptcy. The loan is discharged.

However, if someone has a secured loan, bankruptcy does not matter. As explained at NOLO, the institution to whom the borrower owes the money is still able to take whatever was used as collateral. 

The Cons of Unsecured Personal Loans

  • Lower amount available to borrow than from a secured loan
  • Higher interest rates than from a secured loan
  • Necessitates excellent credit

If you feel that a personal loan is right for you, do research to find the best personal loan supplier for your needs. Especially with the proliferation of online loan institutions, fraud sites can be rampant.

Where to get a personal loan

Many banks offer personal loans, as do credit unions

Online lenders. 

Note that if you do have poor credit, do not be deceived by a “predatory lender” who says, “no one is turned down.” Such institutions are usually “payday lenders” rather than offerers of personal loans, and charge extremely high interest.

If you have poor credit, talk to a friend with good credit about co-signing your loan. But make this an official transaction with your friend/relative, so that you each know the terms involved. Sadly, the quickest way to ruin a friendship is to loan or borrow money from a friend, or in this instance, co-sign a loan.

Always do a search at the Better Business Bureau website to see the rating for the lender you wish to use.

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