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Like the name suggests, unsecured loans do not have any collateral attached to them.
So in the case of default (which should not be the case) the borrower will not loose his or her property.
What lenders look out for to give unsecured loans to borrowers is the borrowers creditworthiness.
These types of loans (unsecured loans) are sometimes referred to as signature loans because the borrower seals the deal with his or her signature.
Having a very good credit history or score can be compared to having a ticket to a movie.
You are able to get a loan much easier with a good credit history than when you have a bad credit history.
Unsecured loans and how it works
Secured and unsecured loans are opposite of each other.
One has an asset placed as security for the loan (secured loan) while the other does not have any collateral as security but the borrowers creditworthiness (unsecured loans)
With the provision of the collateral by the borrower the lender is comfortable lending to the borrower because they can fall on the collateral when there is a default.
However, with unsecured loans, lenders are very careful who they lend to because in the case of default, they (lenders) will be at the losing end.
What lenders do to manage the risk of lending to borrowers who need unsecured loans is that, they give these loans at very high interest rates to minimize the risk.
Also when you go for unsecured loans you must have a very good credit history.
Lenders find out how well your credit history is from credit bureaus who provide them with all your borrowing behavior through a report called a credit report.
When the lenders buy the credit reports from the credit bureaus, they are able to know exactly how your credit behavior has been.
From this report, lenders take a decision as to whether to lend you the money or not.
This decision is solely the responsibilities of the lender and nothing to do with the credit bureau.
All the credit bureau does is to gather all your credit information from all financial institutions you have been to as well as other information from the courts, police department etc.
It helps the lender know exactly who they are dealing with before they finally make a decision on your request for a loan.
Sometimes lenders allow borrowers whose credit scores are not too good to come along with co signers who stand in as guarantors.
These co signers must have a perfect credit score to be able to qualify as cosigners.
Two major factors that contributes to getting unsecured loans
For a lender to agree to give you a loan, they look at several factors before approving the loan.
Unsecured loans do not have any collateral as security for the loan so lenders must consider a few things to make sure you will pay back the loan.
However there are two major factors that lenders make sure that those are in good position before approving the loan. These two are your income and your credit.
Your income determines how much you can get when you go for a loan.
The higher your income the more money you can get from a lender.
When a lender sees your income it should be able to convince them that you will be able to pay back the loan you are asking for.
Lenders always ask for borrowers to bring their prove of income when applying for a loan.
These proof of your income includes your bank statements, tax returns as well as your pay slips.
With your pay slip lenders will be able calculate whether the amount you are requesting for if given will be a burden for you or if it is just ok considering your income.
This calculations done by lenders is called dept to income ratio (DTIR).
Fortunately, if you cant get a loan from your preferred lender because your debt to income ratio is high, there are other lenders who will consider giving you a loan.
Just know that you will be in a very tight corner because you would have gone beyond your capacity (with regards to your income).
Your credit history to most financial institutions especially banks and non-bank financial institutions is very important.
Reason being that they (lenders) are able to tell from your credit history if you will be able to pay off the loan based on your history on your credit report.
On the report provided by the credit bureaus , it is either you have paid off all your loans, in the process of paying or have defaulted on several occasions.
Your credit scores is then used to calculate how creditworthy you are by the lender.
Lenders who give unsecured loans depend a lot on a borrowers creditworthiness to give him or her the loan.
So it is always advantageous to have a good credit all time or aspire to keep your credit history as clean as possible.
If you have already fallen into the bad credit history category, make a conscious effort to make your credit good.
Contrast between secured and unsecured loans
Lets discuss a few of the contrast between these two types of loans (secured and unsecured loans)
• Unsecured loans are risky to lenders because they do not have anything to hold on to in case the borrower defaults.
On the other hand with collateral it makes it much easier to get a loan from a lender because they are secured, hence the name secured loans.
• The main difference between the secured and unsecured loans is that one has a collateral as security for the loan whiles the other doesn’t.
• Tenure for secured and unsecured loans also vary. This is because secured loans have large amounts disbursed to borrowers so the life of the loans are very long, some as long as 20 or more years.
Unsecured loans however have shorter loan period because the money given is usually much smaller that that of secured loans.
• When it comes to interest rates, unsecured loans have very high interest rates attached to them due to the risk associated with such loans.
Whiles its much lower when it comes to secured loans because of the collateral that is used as security for the loan.
Unsecured loan types
Examples of unsecured loans are student loans, credit cards and personal loans but all of these loans can be grouped under three categories.
Unsecured debt comes in several forms namely : revolving loans, a term loan or a consolidated loan.
Consolidation of loans comes in handy when you have a lot of debt which has become overwhelming because of the payments schedules and amount.
What is usually termed a consolidated loan is a huge amount of money which is taken from a lender to pay off all other loans owed.
Sometimes you are able to get a much lower interest rates for the consolidated loan as compared to all the loans you owe put together.
The low interest rate on the consolidated loan makes it easier to pay off and also paying in installment makes it worth it and it is unsecured too.
Though there can be secured consolidated loans which gives borrowers much lower interest rates.
Most borrowers prefer unsecured consolidated loans which can sometimes be difficult to get.
Lenders give unsecured consolidated loans to borrowers who have very good credit scores.
A credit card is a typical example of a revolving loan. This is how a revolving loan works.
It is an arrangement between the borrower and the lender where the lender grants an amount of money for the borrower but instead of the borrower withdrawing the whole amount he or she withdraws in bits.
The amount withdrawn is paid for at a particular time agreed by both parties.
Interest rate is also only paid on the amount withdrawn by the borrower.
This arrangement is binding until the whole amount given by the lender is completely withdrawn and paid by the borrower.
If the borrower is still interested in another loan then another agreement is drawn and agreed on by both parties.
Considered to be one of the most flexible kind of loans, revolving loans allows the borrower to make the decision as to the exact amount that he or she needs.
For a term loan unlike a revolving loan, you get access to the whole amount that is approved.
And you are supposed to pay off the loan in installments at particular dates until the whole amount borrowed is paid off.
Term loans can be either unsecured or secured loans, the only difference is that the interest rates are high with the unsecured loans whiles the secured loans have collaterals as security.
An example of unsecured loans explained further
What is a Credit card?
The physical explanation for a credit card is that it is rectangular in shape and it is made of plastic and other times metal.
This object gives you access to money (loan) that allows you to buy things without giving out physical cash. The money used is loaned and will be paid later with added interest on it.
What the institution that gives out the credit card does is that, they have identified each credit card with :
• Name of the person the card was issued to.
• Card number
• Account number
• Card type (e.g. Visa or master card)
• Name of the institution that gave the card out
• When the card expires, and
• Telephone number of the card holder.
• A validation number
• A place for signature of holder
To make counterfeiting extremely difficult, institutions giving credit cards have holograms on them.
How credit card works
In this time where our society is a drawing towards a cashless society using credit cards are becoming more convenient. However it will only become advantageous to you if you pay back on time so you don’t accrue more interest on your card.
The convenience of having a credit cannot be overstated since you are able to purchase stuff easily.
It doesn’t matter what you want to purchase so far as it falls within your range of credit. From buying food to purchasing an item from an electrical shop.
Knowing how much you will be paying on your credit card debts is an essential factor when choosing your credit card lender.
To avoid any form of interest on your debt will mean paying back your debts on time instead of waiting twenty or thirty days when your grace period expires.
Note : there are credit cards that have rewards on them for usage, so the more you use the card the more your reward.
The rewards can be in the form of cash or sometimes in airline miles.
However such credit cards that come with rewards have higher interest rate on them, so be careful with such credit cards or make sure to pay on time.
No one plans on defaulting on any type of loan, but sometimes things happen that will make you default on your loans.
So to avoid paying so much on credit card loans is safer to get credit cards that have lower interest rates as compared to reward credit cards.
Where you get your credit card from determines exactly where you can use the card.
Having a better credit score helps you get better and quality deals.
As well as lower interest rates comparing it with someone who doesn’t have a good credit score.
Understanding unsecured loans
First of all, unsecured loans are expensive loans because of high interest rates which lenders attach to the loans.
And rightly so because there are no collaterals as security for unsecured loans so are much more riskier to give out.
No financial institution works to make a loss so the strategy is to make profit and even the worse should happen it should be minimal.
With this in the minds of most lenders, all kinds of methods are used to minimize risk by borrowers.
That is why when secured loans are given, the collateral is kept as a security to loan.
When a secured is fully paid for the collateral is then transferred back into the name of the borrower.
But if the worse happens and there is a default the lender goes ahead and sells the asset to make back the money loaned.
Lenders prefer this kind of loans because they are secured and don’t need to go about chasing borrowers for their monies.
For the unsecured loans on the other hand the lender will have to use the services of collection agencies and sometimes the courts to be able to recoup the monies borrowers owe.
Borrowers also prefer unsecured loans even though they come at a higher interest rates, because in the case of a default they do not have to lose any asset.
When you decide to go for unsecured loans know that the amount you will be able to get will greatly depend on how much you earn, your dept to income ratio as well as your credit scores.
Requiring a bigger amount will mean you have to use a collateral as security or if your credit scores are close to perfect.
Advantages of unsecured loans
• Available to all persons
Everyone needs money urgently one point in time in their lives and having easy access to it is what makes the difference.
Fortunately for unsecured loans everyone can have access to money because you don’t need a collateral as security for the loan.
• Fear of losing an asset is not the case for unsecured loans
In the case of secured loans, you will need an asset to be used as security for the loan you ask for.
Most home owners use their homes as collateral for loans but with unsecured loans, you don’t have to think of losing your property in case of default.
Due to the above, the risk for a borrower taking unsecured loans is very minimal as compared to secured loans.
• Processing of loan is fast
Processing loans can sometimes take a little longer than you will expect.
But processing unsecured loans can be fast because there is no collateral to verify or value so the process is quite straightforward.
Sometimes you can have your loan the same day you applied for it or latest by three working days.
Also with a good credit score you can have a lower interest rate as compared to someone with a credit score that is bad.
• Declaring bankruptcy
In case you declare bankruptcy, whether for yourself or for your company, when you have an unsecured loan the court can easily dismiss your loan.
This is not possible in the case of secured loans.
• Smaller amounts are available
Lenders of unsecured loans do not need collateral before giving out the loans.
And this is quite risky for them giving borrowers unsecured loans.
So to cut down on the risk, lenders give out much smaller amounts as unsecured loans to minimize the risk.
Disadvantages of unsecured loans
• Interest rates are high with unsecured loans
Unsecured loans also sometimes referred to as signature loans are backed mainly by the trust the lender has for the borrower.
Also a borrower with a very good credit scores helps with acquiring the loan.
But since in case of default, the lender does not have anything to fall on, they give out the loans with very high interest rates.
This serves a way to cushion themselves (lenders) a bit from the risk they are taking by lending without any security.
• Small amounts are given
No security loans (unsecured loans) are given by lenders to borrowers who do not have collateral.
However, the catch is that you will not get a huge amount from the lender because, there is nothing to fall on in case there is a default.
Giving this type of loan in the first place is a huge risk being taken by the lender. So the amounts given out are under a lot of scrutiny.
• No flexibility in payments
Taking unsecured loans means you and the lender agrees to you paying back the loan in installments.
What this means is that, you will pay the loan at specific times and specific amounts for a period of time.
This agreement is hardly changed especially when there is no adjustments in the base rate.
Even in the case the base rate goes up (which is the case most of the time) some lenders informs the borrower and adds some more time to the paying time.
The amount does not change. This is rare. Most of the times when a deal is reached it stands till the borrower finishes paying off his or her loan.
There are several loans but unsecured loans gives a lot of people out there the chance to get a loan regardless of whether you are a home owner or not.
The only thing is that you must have a very good credit score to be able to get a reasonable interest rate on the loan.
Otherwise the interest rate on your loan will be very high and rightly so because the lender will not have anything to fall on when you default on the loan.
Before you decide on going for unsecured loans, it will be in your best interest to weigh the pros and cons of it and see if the pros outweigh the cons for you before you go for it.
Sometimes the cons might be more than the pros but due to your need for the money, you might overlook it.
What you have to bare in mind is that, is what you need the money for that important and urgent that you have to pay so much for it?
If the answer is yes then go for it, but if the answer is no or maybe, you may have to reconsider your decision.
Lenders are very ruthless when it comes to retrieving their monies from borrowers who have defaulted in payment.
The stress borrowers go through from lenders is not worth going through so a lot of thought must go into the decision of taking a loan.
Disclaimer: All loans offered through this website are subject to credit and underwriting approval. AfterLoans.ca is a lead referral company, not a lender. AfterLoans only works with financial service providers that adhere to Canadian laws and regulations. Our lenders lend from $500-$5,000. Loans amortization is between 6-36 months. APRs range from 19.99% to 55%. The actual APR charged will depend on the lender’s assessment of your credit profile. For example, on a $1000 loan borrowed for 12 months at 29.9%, the monthly payment will be $97.24; with a total repayment, including interest, of $1166.88 There is also lender’s optional loan protection policy. In the event of a missed payment an insufficient funds fee of around 45$ may be charged (dependent on the lender). If you default on your loan payment plan the lender may terminate the plan and the remaining balance will become payable immediately. Our lenders employ fair debt collection practices, but will pursue the payment of Outstanding debts to the full extent that Canadian law allows.