Unsecured loans are loans not backed by an underlying asset. Unsecured loans include credit cards, medical bills, utility bills and other types of loans or credit that were extended without a collateral requirement. This type of debt presents a high risk for lenders, also referred to as the creditor, since they may have to sue for repayment if the borrower doesn’t repay the full amount owed.
In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors. The unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors.
In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.
Under risk-based pricing, creditors tend to demand extremely high interest rates as a condition of extending unsecured debt. The maximum loss on a properly collateralized loan is the difference between the fair market value of the collateral and the outstanding debt. Thus, in the context of secured lending, the use of collateral reduces the size of the “bet” taken by the creditor on the debtor’s creditworthiness. Without collateral, the creditor stands to lose the entire sum outstanding at the point of default, and must boost the interest rate to price in that risk. Where high interest rates are considered usurious, unsecured loans are either not made at all, or are made by loan sharks unafraid of the law.
Unsecured loans are often sought out in cases where additional capital is required although existing (but not necessarily all) assets have been pledged to secure prior debt. Secured lenders will more often than not include language in the loan agreement that prevents debtor from assuming additional secured loans or pledging any assets to a creditor.
An unsecured loan is a loan that is issued and supported only by the borrower’s creditworthiness, rather than by any type of collateral. An unsecured loan is one that is obtained without the use of property as collateral for the loan, and it is also called a signature loan or a personal loan. Borrowers generally must have high credit ratings to be approved for certain unsecured loans.
Because an unsecured loan is not guaranteed by any type of property, these loans are bigger risks for lenders and, as such, typically have higher interest rates than secured loans such as mortgages or car loans.
Unsecured debt can be personal or business debt. As a result of the high risk to the lender, unsecured debt tends to come with high interest rates, which increases the financial burden on the borrower. Borrowers can wipe out unsecured debt by declaring bankruptcy, but taking this dramatic step makes it more difficult to obtain a future unsecured loan.
If a person fails to make payments on unsecured debt, the creditor first contacts him to try and receive payment. If the borrower and the creditor cannot reach a repayment agreement, the creditor’s options include reporting the delinquent debt to a credit reporting agency, selling the debt to a collection agency and filing a lawsuit. If the creditor files a lawsuit in state or federal court, a court ruling may force the borrower to use specific assets to repay the unsecured debt.
Term loans, in contrast, are loans that the borrower repays in equal installments until the loan is paid off at the end of its term. While these types of loans are often affiliated with secured loans such as mortgages and car loans, there are also unsecured term loans. A consolidation loan to pay off credit cards or a signature loan from a bank would be considered unsecured term loans.
A guarantor loan is a type of unsecured loan that requires a guarantor to co-sign the credit agreement. A guarantor is a person who agrees to repay the borrower’s debt should the borrower default on agreed repayments. The guarantor is often a family member or trusted friend who has a better credit history than the person taking out the loan and the arrangement is, therefore, viewed as less risky by the lender. A guarantor loan can, consequently, enable someone to borrow either more money, or the same amount at a lower rate of interest, than they would otherwise be able to secure through a more traditional type of loan.
Guarantor loans are sometimes seen as alternatives to payday loans and associated with the sub-prime finance industry, due to them being aimed at people with a less than perfect credit score, because of missed payments towards debt in the past. However, this is only one aspect of guarantor loans. They are also aimed at young people who have no credit score, due to having never obtained credit in the past such as new graduates just embarking on their career – these people are often high earners with sensible financial habits so can afford the repayments but do not have the credit history to reassure the lender about the level of risk. As mainstream lending criteria is often automated and does not come with a personal review of the applicant’s financial circumstances it is sometimes the only way a young adult in their first job can secure a loan.
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