An unsecured loan is a type of personal loans that are processed without the need to provide collateral. It is also known as a signature loan because the borrower’s signature on the loan agreement is all that is required to bring to the table.
As a borrower, all you need to do is to promise to repay on time, but backing it up with collateral is not required.Collateral is an asset (can be your property, vehicle, gadgets, etc.) that a loan applicant pledges to provide to be able to get an approval for a loan.
When you apply for unsecured loans, instead of agreeing to pledge for an asset, a borrower’s qualification is based on the following:
Monthly income or salary
A lender is not in a position to take any physical assets (this may be your property or a vehicle) if a borrower stops paying on time on an unsecured loan.
3 Different Forms of Unsecured Loans
There are different types of unsecured loans, this includes the following:
Credit card – Although you may not consider a credit card as a loan, remember that you are still borrowing money that you spend using credit cards.
Student loan – Although some of us take cold, hard cash to pay your student loans, tuition fees, and miscellaneous fees in the Department of Education (DepEd) are usually not secured.
Personal loan – These types of personal loans are offered by the banking institutions, credit union, and lenders online – are not secured loans that a borrower can utilize for whatever purpose
Unsecured Loans Versus Secured Loans: What are the Differences?
To further understand how an unsecured loan differs from a secured loan, let us tackle secured loans:
Auto loans – When you borrow to be able to buy your dream car (or get a car loan against your vehicle’s title), your lender has all the right to acquire your vehicle from you if you fail to repay the loan. Having said that, the borrower’s vehicle serves as the collateral, which makes an auto loan a secured loan.
Mortgage loans (also called as a home loan) – Whether you borrowed money to buy your dream house or get a 2nd mortgage, you are exposing yourself to risks of being forced to leave your own home because of foreclosure if you fail to pay the loan.
Secured credit cards – Borrowers with a poor or bad credit score and no bad history have higher chances of obtaining a secured credit card. With these types of cards, you send a deposit to the card issuer to hold as collateral. You are provided a credit card with a maximum limit that is usually the same amount you have deposited. For instance, if a borrower cashes in $500.00 as collateral, high chances are, you will get approved for a line of credit of the exact, same amount. If a borrower failed to pay the credit card’s bill on time, the card’s issuer has the right to use the borrower’s deposited amount to pay the card’s remaining balance.
Business loans – These types of personal loans can either be secured and unsecured. If a lender requires a borrower to guarantee, you will have to pledge to provide your house (or other assets) as the loan collateral.
Can A secured loan damage my credit?
Even with a secured loan, you are still prone to damaging your credit report and score if you fail to repay the loan on the said due date. The mere fact that your lender acquires your collateral does not change that.
As a matter of fact, some lenders sell the collateral they acquire. However, the sales acquired are not always enough to cover the unsettled loan balance. If that ever happens, the borrower loses the asset/s provided, damage his/her credit score and report, plus still owe the cash on the loan agreement because of having a deficiency judgment.
In addition to that, lenders may charge hefty penalty fees, which will increase the total amount that the borrower initially owed. Eventually, the lending company or direct lenders have the power to legal actions. If the lender or lending company win the judgment, chances are, they have the right to take the cash out of the borrower’s bank account or automatically garnish your monthly wage.
How to Get Approval for an Unsecured Loan?
When applying for an unsecured loan, there is no need for a borrower to pledge any of his assets as collateral.
Instead, the lender will evaluate the loan applicant/application based on the person’s financial capacity to pay (as opposed to your lender’s ability to sell the collateral and collect the money that the borrower owes).
Factors to Get Approval for Unsecured Loans
Lenders online or on-site look at numerous factors to determine if a borrower can pay on-time or not. Here are a few factors that you need to check before applying for unsecured loans:
Credit history and report – Lenders check the borrowing/loaning history to see if a loan applicant has successfully paid all the personal loans he used in the past. Based on the financial records and information of the borrower’s credit report, a computer computes the credit score – this serves as an easy way to evaluate a person’s creditworthiness. To get approval for an unsecured loan, you must have a good credit standing. If you only borrowed a small amount in the past (or you have bad credit because you were unable to pay on time
Credit score – In line with the credit history and report is the borrower’s credit score. So before applying for unsecured loans, you need to improve your credit score first for higher chances of getting an approval.
Monthly income or salary – Lenders online or on-site want to make sure that a loan applicant has enough monthly income or salary to repay the loan.
When applying for a loan, lenders will require you to give a proof of payslip (this includes, but not limited to the borrower’s pay stubs, tax returns, and a bank statement). Once you can provide the following, afterward, the lenders will see to it if a loan applicant is worthy of being granted for a new loan or not. Typically, lenders do this by computing an applicant’s debt-to-income (DTI) ratio.
What Should I Do If I’m Not Qualified to Get an Unsecured Loan?
If a loan applicant is not qualified to get an unsecured loan, here are the possible options to consider:
Co-signer – One option is to get a co-signer or co-guarantor to assist a borrower with his/her loan application. However, take note that this option can put both of the concerning parties in a complicated situation. This is because the borrower’s co-signer or co-guarantor will also be responsible for paying your debt should you miss to pay on time.
Secured debt – Another option is by pledging to provide collateral (borrower’s assets). However, this option is accompanied with high risks of losing assets if the borrower is unable to pay on the due date. A borrower can pledge for his/her physical assets, or he/she can also transfer cash through a bank account (and other financial assets) to secure a loan.
Less debt-to-income (DTI) ratio – If a borrower’s debt-to-income (DTI) ratio is causing financial issues, a smaller loan amount should result in lower monthly installments. If a loan applicant is still unable to accomplish what a borrower needs with low debt, that may work well.