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If you’re researching personal loans, the term unsecured personal loan usually comes up. But how is a secured loan different from an unsecured loan?
Simply put, unsecured loans do not require collateral while secured loans do.
We’ll explain how unsecured personal loans work, how they differ from secured loans and the pros and cons to weigh when considering your options.
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How Do Unsecured Personal Loans Work?
Unsecured personal loans don’t require collateral. If you don’t put down collateral for a loan, that means you aren’t making a down payment or giving the lender any claim to your personal property.
That translates to a riskier proposition for the lender because, in essence, they only have your word that you’ll pay the loan back. To make sure they’re lending their money responsibly, they’ll review your credit history and debt-to-income (DTI) ratio as a part of the application process.
One of the ways lenders will look to offset the risk of an unsecured loan is by charging higher interest rates than they would for loans that come with collateral.
What happens if you default on an unsecured loan?
A word of warning: Defaulting on an unsecured loan will still have negative consequences. While you won’t be giving up any collateral, defaulting can decimate your credit score. And, if your debt goes to a collection agency, they may pursue more drastic measures – such as suing you for the funds you owe or even asking a judge to garnish your wages.
Unsecured Personal Loans vs. Secured Personal Loans
Here’s a table to help you visualize the differences between these two loan types.
|Unsecured Personal Loan
|Secured Personal Loan
|Higher interest rate
|Higher loan amounts
|More flexible use of funds
Almost all the differences between these two loan types stem from the presence or absence of collateral. If you put down collateral for a loan, you’ll likely be eligible for higher loan amounts and lower interest rates.
Acceptable forms of collateral for secured personal loans include:
- Bank accounts
What’s acceptable collateral comes down to the discretion of the lender and the value of the asset.
Pros and Cons of Unsecured Personal Loans
Here’s a list of the advantages and disadvantages of the unsecured personal loan variety.
You don’t have to give a lender access to an asset to receive the loan.
You can usually get access to the funds from an unsecured personal loan quickly, sometimes even within one business day.
You have a lot of freedom with how you can use the funds from unsecured personal loans, making them a popular option.
You’ll pay higher interest rates for unsecured loans than you will for secured ones.
You won’t be able to borrow as much with an unsecured personal loan.
Unsecured personal loans tend to have shorter repayment terms than secured loans, which can translate into higher monthly payments.
Personal Unsecured Loan FAQs
Here are some frequently asked questions regarding unsecured personal loans.
Are unsecured loans bad?
Unsecured loans aren’t inherently good or bad. They can be riskier to lenders, which can lead to higher interest rates for you. But there are perks as well, like fast access to funds and not needing collateral, so you’ll need to evaluate the tradeoffs based on your circumstances.
What can I use an unsecured personal loan for?
From emergencies to home improvement to debt consolidation, unsecured personal loans can be used for almost anything. That’s one of the reasons they’re so popular. Just be sure you have a plan to pay the loan back before taking it out.
Where do I get an unsecured personal loan?
You can get unsecured personal loans through online lenders, banks and credit unions.
Final Thoughts on Unsecured Personal Loans
No collateral doesn’t mean the loan comes free. You’ll still pay interest on the loan, and if you can’t pay it back, there will be negative consequences to your credit score and potentially more.
Do your due diligence, and make sure to talk things through with your lender before applying for a personal loan.
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The Short Version
- Unsecured personal loans are loans that don’t require collateral. The lender will review your credit history and debt-to-income ratio to make a decision on your loan application
- Even without collateral, failure to repay an unsecured loan can still negatively impact your credit score. If it goes to a collection agency, things can escalate further
- Besides not needing collateral, the pros of these loans include fast access to funds and flexibility in what they can be used for