
What Are Unsecured Loans?
If you need a loan that does not require collateral, then an unsecured loan should be suitable. Lenders agree to issue unsecured loans based on the borrower's creditworthiness and not on their assets as collateral. These can be, for example, credit cards, personal loans, and students loans.
Unsecured personal loans require higher credit scores to be approved, as they pose a greater risk to lenders than secured loans. Although lenders decide whether or not to approve an unsecured loan depending on the credit score and other requirements, several laws protect borrowers from discriminatory lending practices.
How an unsecured loan works?
Signature loans or personal loans (as unsecured loans are often called) are approved without providing property or other assets as collateral. The borrower's credit rating is the primary importance in obtaining such loans. If a borrower is looking for approval for an unsecured loan, their main advantage should be a high credit score.
When credit points are not enough, the borrower provides a guarantor in some cases. The guarantor undertakes to fulfill the borrower's debt obligations to the lender if the borrower does not pay interest on the loan or the principal debt.
The major types of unsecured loans
There are several options for unsecured personal loans that lenders usually offer. It is necessary to study each type carefully to maximize the loan benefits. Your preferences should depend on your goals and the loan details.
There are five major types of unsecured personal loans in the USA:
Signature loan
The primary type of unsecured loan is a signature loan, not secured by anything other than the borrower's signature. Such loans are provided by lending companies, banks, and credit unions. You can use them for any purpose. However, to avoid legal problems, make sure that you know all possible restrictions associated with the lender of the loan you have chosen.
You borrow money and return it with a monthly fixed payment. Usually, such loans are repaid in installments, and low interest rates make such loans very attractive to potential borrowers.
A personal line of credit
Another popular form of unsecured personal loan is a personal line of credit. Its difference from the previous type is that you can use and return the amount approved by your bank. For example, you have approved an unsecured personal credit line of $ 10,000. You can get $3,000 from it to pay for the current apartment renovation project. At the same time, $7000 will be at your disposal as soon as you pay the previous $3000. Interest is paid only on the loan principal you have used, and it is often lower than with a credit card loan.
Credit cards as loans
Many people prefer to use credit cards. When using a credit card, a person borrows everything they need at the right time. The loan amount is limited only by the credit limit of the card. Despite the relatively high interest rate, credit cards are pretty popular. Some borrowers have the opportunity to get a teaser rate and even a rate at zero percent. You should carefully study all available proposals to not regret choosing a credit card.
Peer-to-peer loan
One of the new types of financing is peer-to-peer credit. This type of loan involves borrowing from individuals, not from a bank. The loan request is posted online on websites, and individuals have the opportunity to step in and finance this loan. Fixed installment payments repay these loans. Different interest rates and conditions allow the borrower to make their choice. But even in this case, your credit rating is of great importance.
Student loans
Student loans are a good choice for financing education. Designed for students, they often have flexible repayment options, interest subsidies, grace periods, and other features. Usually, the lender does not require the borrower to provide their credit rating, and the only necessary condition is that the borrower must be a student.
Ways to Get an Unsecured Loans
The borrower usually accomplishes an online pre-qualification to compare the likely rates. After it, you do not need to pass several strict credit checks. In addition, the lender can approve your loan application online. Demonstration of assets is not required since the loan is without collateral.
Five Steps How to Get an Unsecured Loan
Applying for an unsecured loan is more straightforward than applying for a secured loan, and a borrower can fill it out online. However, follow these five steps to make sure that you make a good deal when applying for an unsecured loan.
- Check whether your credit report points correspond to the required amount for the loan you need. As the approval of the loan depends on the borrower's creditworthiness, the borrower's credit score must be from 610 to 640. Otherwise, they will not be able to apply for a personal loan. If your FICO rating is at least 720, you can expect the most competitive rates. Before applying, it is easy to check your credit rating through free online services.
- Give an honest estimate of your budget. Having studied your current income and expenses, you will understand how solvent you are. Keep in mind that late payments can negatively affect your credit score. In addition, lenders are interested in the borrower's debt to income (DTI) ratio.
- Shop for creditors and pre-qualification. Study lenders' offers with the most competitive APR and flexible loan repayment terms. The online pre-qualification process will allow you, as a prospective borrower, to see what APR and loan terms are likely to be offered to you.
- Carefully collect all the necessary documentation. After studying the application process, start collecting the required documentation. Pre-prepared tax returns or a W-2 will speed up the application process, and the loan will be approved and financed faster.
- Write an official application and submit it. Fill out loan applications going online or in person. Approval and financing are often possible on the same or the next day. However, each lender decides the application process, and you may need to negotiate the details in person or by phone.
How to apply for an unsecured loan?
The application process depends on the lender, and it can be an online lender, a bank lender, or a credit union. Online applications are usually made without telephone conversations and can be funded on the same day.
Banking applications, in some cases, require a personal visit to complete the process. In addition, the bank's requirement for filing an application may be an existing account.
Credit Union Applications: Membership in a credit union gives you the right to borrow its money. It is often related to where you live or work. But several credit unions accept everyone who wants to become a member.
You should provide the following to apply for an unsecured personal loan:
- Your phone number;
- Your social security number;
- Information about your employer;
- The history of education;
- Financial information about pension assets, household capital, as well as bank account information.
How to repay an unsecured loan debt?
Whena borrower apply for an unsecured personal loan, lenders often insist that they agree to automatic monthly payments for money to be debited from their bank account for loan repayments. Many lenders offer this as a prerequisite for obtaining an unsecured loan. The payment will be made regularly and on time. But it is sometimes complicated to cancel monthly payments without the lender's permission.
There are several options for debt repayment in the United States. You choose the one that suits you, depending on your income, expenses, and how much of the debt you want to repay. To repay the debt on an unsecured loan, you can consider five options.
Pay yourself
Such payment involves an independent assessment of your debt, developing a repayment plan, and implementing it. At the same time, borrowers often turn to lenders to establish a payment schedule or a lower interest rate. This method assumes the borrower's responsibility for sending monthly loan payments to the lender.
Consulting on consumer loans
You can seek a credit counseling agency that will offer you an affordable monthly payment for all your unsecured debt within your income. Providing a debt management plan (DMP) is also part of their function, and such a plan usually offers a lower minimum payment and a lower interest rate. Credit counseling with DMP can take three to five years, depending on the number of your loans.
Debt consolidation
You also can consolidate credit card debt. This solution involves combining all your debts into one loan payment. Sometimes, you can get a new debt consolidation loan to pay off your unsecured debt. However, you need to have a good credit rating to go this way. All your loans are combined into one monthly loan payment in all other cases.
Debt settlement
You can also solve the debt problem by paying a monthly fee to a debt settlement company. Such a company agrees on a lump sum payment, and this payout is less than the total amount you owe. Once the settlement amount is reached, the debt settlement firm will use your money to pay for the settlement. But still, your creditors don't need to agree to the settlement proposal. It can happen that you won't get a refund if the settlement is not successful. According to the American Fair Credit Council, the average settlement percentage is 78%, and there is also a tax on the debt forgiven.
Bankruptcy
Bankruptcy is one of the ways to close unsecured debts. To do this, you need to pass a means test. Credit counseling should also take place. If it shows that your income is not enough to pay off your debt, a specific decision will be made. According to your state law, you may have to give up some part of your property to pay off the debt. In bankruptcy, the bulk of your unsecured debt is most often repaid. However, this cannot apply to alimony, tax debts, and student loans.
Pros and Cons of Unsecured Loans
Flexibility and low requirements for applications create unsecured loans popularity among borrowers. Among the advantages of unsecured loans there are the following:
Advantages of Unsecured Loans
- The borrower's possession of a real estate, transport, or valuable assets is not necessary to obtain an unsecured loan.
- The borrower does not risk their property in case of default on an unsecured loan.
- Unsecured loans can be used for a variety of purposes. Since the application process does not require an assessment of collateral, it is easier and faster than when applying for a secured loan.
Disadvantages of Unsecured Loans
However, it is necessary to remember the disadvantages of unsecured loans:
- The borrower's credit rating may deteriorate significantly with missed payments.
- Default may threaten the borrower with a lawsuit and subsequent collection of wages.
- Lenders prefer borrowers with a higher credit score. Interest rates on unsecured loans may be higher than on secured loans.
- This is associated with a higher risk for creditors.
Legal Regulation of the Unsecured Loans Market in the USA
Laws protect borrowers from discriminatory lending practices. Under the Equal Credit Opportunity Act (ECOA), it is illegal for lenders to use race, skin color, gender, religion, or other factors unrelated to creditworthiness when evaluating a loan application or setting loan terms and any other aspect of a loan transaction. ECOA was enacted in 1974.
The Consumer Financial Protection Bureau (CFPB) plays a leading role in overseeing the observance and enforcement of the rights of citizens acting as borrowers. In July 2020, it issued a Request for Information requesting public comments. The aim was to identify the possibilities of ECOA in ensuring non-discriminatory access to loans. Kathleen L. Kraninger, director of the CFPB, expressed her opinion on this issue: “Clear standards help protect African Americans and other minorities, but the CFPB must support them with actions to make sure that creditors and others follow the law.”
The real cost of an unsecured loan
There are certain risks accompanying some aspects of unsecured personal loans, and you need to consider them before signing the loan agreement.
Interest rate
You don't have to apply for a loan simply if you have the right to do so. Indeed, there are loans with favorable interest rates (below 10%). Simultaneously, some are three to tenfold times higher. Your credit rating is the determining factor on which the interest rates on these loans depend. Still, lenders can demand no more than the rates that fall under specific laws.
It is better not to rely on annual interest rates (APR) when choosing a loan, as APRs can mislead you. A much more reliable way is to study the total amount you will pay on loan. Do not forget to include interest, fees, and the principal amount you will have to pay back during the loan term. This approach is the best.
Penalties for early repayment
When studying all the loan details when applying for a loan, do not forget to find out if you can repay it ahead of time. For early repayment of some loans, a fine or fee is charged. If you want to pay off the loan ahead of time, carefully study the conditions to ensure no prepayment penalty.
Large down payments
The prepayment fees for issuing a loan can be quite different. Since it is crucial for you as a borrower to know whether the prepayment fees you will have to pay are fair and correspond to the average market level, ask this question in advance. Do not forget that many suppliers with different conditions are ready to offer you a better deal.
Privacy concerns
When applying for a loan from a lending company, bank or credit union, confidentiality is ensured by strict rules. In other cases, the contract's confidentiality may be much less formal. Despite the exact requirements for all creditors, some of them may not comply with this rule.
Insurance
The sale of insurance accompanies some personal loans, and it is required to protect the loan in case “unforeseen life events” affect your ability to pay.
Pre-calculated interest
According to the initial payment schedule, the interest is pre-calculated during the calculation of your loan. A simple percentage is calculated based on the amount you owe today, and it is vital to determine how the lender calculates the interest. To repay the loan quickly, you need a simple percentage.
Payday loans
One form of short-term personal loan is a payday loan. Consumers are usually advised to avoid such loans for some reason. Due to high interest rates and harsh conditions set by payday lenders, borrowers are often forced to extend the loan on additional terms.
Origination fees
The lender may request origination fees related to the processing of loan documents, among other things. You should know about all loan details in advance.
Optional additions
A loan is a relatively simple form of arrangement. You receive the money and return it with interest. But sometimes, the company starts manipulating you by offering you payment holidays, cashback offers, or other temptations. At the same time, you should have a clear idea that it is not profitable for a company to lose money on a deal, and only you can lose. Simplicity should be the hallmark of a personal loan.
Loans almost always add up in favor of the lender, not the borrower. It can be explained by poor knowledge of arbitration. Think about saving on the purchase before proceeding with the loan. Having discovered all the possible risks for the selected loan, you will be ready for registration or further search. We recommend using a personal loan calculator to determine the monthly payment, loan terms, and the fixed interest rate.
So, your credit score is the most critical indicator of your financial health. It immediately makes an impression on the lender because it is not difficult to determine whether you are using the loan responsibly. New loans or new credit lines are approved more quickly if you have a good credit history. The lowest interest rates for borrowing are available only to those with a high credit rating.
Conclusion
If you have come to the decision that you need a loan, take the trouble to prepare for the following issues:
- Are your financial statements ready to be provided (they will vary depending on the lender)? Is it essential for you to see the application process?
- How fast do you want to get the money?
- What is the status of your credit rating and business credit history?
- What can you do to expect the most competitive rates?
- Are you satisfied with applying online, or do you prefer to do it in person?
- What minimum loan amount do you agree to fill your business need?
- What amount would be an excellent credit for you?
- Is there a type of loan that you are not interested in anyway?
Most borrowers prefer to receive unsecured personal loans and not risk their property as collateral. Lenders can approve such a loan only when confident that the applicant can make monthly payments without difficulty. When obtaining an unsecured loan, your previous repayments, personal and business credit scores, income, debt to income ratio, and other creditworthiness indicators are important. If you are a future borrower, take care of your safety by studying all possible conditions.