What Are Unsecured Loans?

The need to borrow money might start in childhood or adolescence when you ask your parents or friend to spot you a couple of bucks to see a movie or to buy a toy or popular game. As an adult, borrowing money is required for larger, more significant purchases such as a home, an automobile or recreational vehicle.

For many purchases, credit cards or installment payments, the typical method is through secured loans, or those with which the person receiving the loan supplies some sort of collateral. There is another form of a loan, however, where the person desiring the loan can be approved without pledging an asset to back the granted funds. These loans are known as unsecured loans.

In an unsecured loan, the borrower does not put up collateral against what is lent. Qualifying for an unsecured loan and the degree to which a person is approved is dependent on their credit score, credit history, income and employment status.

Unsecured loans can be attractive for the very reason that collateral is not a factor. Your property is not at risk, meaning if you default on an unsecured loan the creditor cannot step in and take your home away from you, as would be the case when defaulted on a mortgage (which is a secured loan).

Unsecured loans usually involve a much simpler application process. Because such a loan is largely based on credit score, the lender only has to determine the score and can make an approval decision within one business day.

A downside of obtaining an unsecured loan is that you will pay a higher interest rate. Rates will vary depending on the lender, but be prepared to pay additional percentage points.

In addition, unsecured loans have strict limits on how much money can be borrowed. With a secured mortgage loan, your approval amount can essentially be whatever you qualify for, whether it be $100,000 or over $1 million. Unsecured loans, however, will be much lower. You will also have less time to pay back your unsecured loan than with a secured loan. A secured loan often must be repaid within three or four years, as opposed to the 10, 15, 20 or 30 years you'll find with a secured loan. One reason for this shorter repayment period is because since the loan amount is smaller, there is no prudent reason to spread the payment out across several years.

Another potential pitfall with unsecured loans is that the debt incurred in obtaining such a loan only leads to more debt piling up. People often use unsecured loans to finance other purchases that are in turn financed or paid for through installments.

Unsecured loans are often granted in the form of personal loans. A popular loan, personal loans can be used for essentially anything-home improvements and renovations, medical costs, weddings, vacations, and even for purchasing jewelry or expensive electronics.

Another common unsecured loan is a student loan, either for undergraduate or graduate studies. In these examples, the student puts up no collateral and instead promises to pay back money loaned for tuition, books, and other educational expenses. Student loans do not need to be repaid until the student has completed his or her studies. If the person fails to pay back the loan, the financial institution can garnish wages or tax refunds to pay on the outstanding balance.

Credit cards are also a form of unsecured debt. They, too, carry high-interest rates and can apply steep penalties for late payments or by exceeding credit limits.

Educational loans can often be unavoidable for the student seeking to complete a degree. However, most financial experts caution people when considering personal loans and in applying for credit cards. In any case, diligence, discipline, and prudence should be exercised when assuming unsecured debt.

People who can make a plan to be dedicated to repaying the loans can avoid the dangers and pitfalls that so often ensnare those who become entangled in excess unsecured debt.

Need help with another personal loan question? Find the answer on our Personal Loans FAQ page.