What Is An Unsecured Loan?

You don’t always have to put your assets on the line in order to secure a loan. An unsecured loan is a flexible finance option that relies on your creditworthiness and loan history. If you need a straightforward way to get cash fast without risking your house or car, explore how you can utilize an unsecured loan.

Dig Deeper: What Is An Unsecured Loan?

An unsecured loan is based on a borrower’s creditworthiness, income, and repayment capacity. To apply for an unsecured loan, you don’t need to offer any of your assets, like a house or vehicle, to secure the loan. Instead, an unsecured loan is determined by these factors:

Credit check – If you have a high enough credit score, you can secure one of these loans. Typically, your credit score should be a minimum of “good” at 660 or higher. Your credit score is comprised of your payment history, credit utilization, length of credit history, your credit mix (the types of loans you have), and how many credit inquiries you have. If you need help with building your credit score, check out these tips and tricks.
Debt-to-income ratio – A lender doesn’t want to lend you money if you can barely keep up with your current debt. Before approving a loan, financial institutions will calculate your debt-to-income ratio, which is a percentage of how much of your gross income is used to pay off your monthly debt. A general good rule of thumb is to have no more than 36% of your income dedicated to debt.
Income – You need proof that you can pay back the loan you are applying for. Having a job and showing pay stubs may be required to secure any loan, especially an unsecured loan. Supplying an income statement will show financial institutions how much you make and help calculate how much you can borrow.

Examples of Unsecured Loans

There are three types of unsecured loans that people typically apply for.

Personal loans – This finance option is best for borrowers who know exactly how much they need, and can pay the loan back in a set term. The repayment timeline on these loans is usually within 10 years of the loan being funded. It provides you with a lump sum upfront that you can use for nearly everything, such as a wedding, holiday expenses, or vacations.
Student loans – Student loans are designed to take care of higher education costs, such as tuition, room and board, books, and even meals. It’s a lump sum that you give to your chosen school.
Credit cards – Credit cards are a revolving line of credit that people can tap into continuously. There is a set limit, and you can borrow up to that limit anytime. The funds are available whenever you need them. It’s a common finance option that can be used for almost any purchase.

These options are great for people who need to consolidate debt or have a large upcoming purchase.

Advantages & Disadvantages

Unsecured loans are a popular financing option compared to their secure loan counterpart for the reasons below. However, keep in mind the downsides.

Faster approval process – Without collateral, the approval process gets faster. Most financial institutions can approve an unsecured loan quickly since it is based on your creditworthiness, income, and repayment history – empirical data that is easy to sort through rather than equating a value to an asset.
No collateral – Unsecured loans require less risk on your end. If you don’t pay back the loan, you won’t have one of your assets repossessed by the financial institution. However, it is still very important to maintain your monthly payments. Too many missed payments or a default on your unsecured loan can result in a collection agency garnishing your wages and hurting your credit score. This will make it difficult to apply for a loan in the future.
Fixed interest rate – Plan your future finances more efficiently, knowing how much you are going to pay in interest the entire length of your loan. Some secured loan options have variable rates and can change on a whim, sometimes resulting in you paying more money long-term.

The biggest downside to unsecured loans is the higher interest rates and shorter terms. Some people mismanage their unsecured loans, especially with credit cards, and end up borrowing too much at once, then can barely pay back the minimal monthly balance. Since these unsecured loans have higher interest rates, you will end up paying way more for the product you purchased if you can’t keep up with the payments.

Before applying for an unsecured loan, make sure you have a goal in mind: are you consolidating debt, funding your post-secondary education, or covering an unexpected expense? Keeping your eye on the target with these types of loans will help you achieve your long-term financial goals.