Most people or businesses look at an unsecured loan as a last resort for much-needed funding.
However, not everyone understands that there are both benefits and drawbacks to this avenue of raising money for personal or business use.
Whether or not you’re considering getting one right now, it’s important to understand what an unsecured loan means for you and your business in the long run.
Pros of Unsecured Loans
Potential Low Rates
Having an excellent credit score can put borrowers in a good position when applying for an unsecured loan. More specifically, it makes them more likely to secure one with a low interest rate.
In some cases, those rates could even come close to those of secured loans. Because of this, applying for an unsecured loan may be a fast and relatively affordable way to get your hands on the necessary funds.
A secured loan requires some form of collateral. By its very name, an unsecured loan is not secured by anything other than the borrower’s promise to repay the debt.
It’s not a home equity loan where someone puts up their home as collateral for the loan, for example, where an inability to pay could lead to the lender taking possession of and liquidating the asset to recoup the principal.
You don’t have to worry about such matters with an unsecured loan.
Faster Access to Money
Secured loans require extra documents, which may include proof of salary and asset ownership.
When applying for an unsecured loan, much of the documentation rules are relaxed. This usually leads to faster approvals and fund releases.
Getting a loan is hard enough for most people and companies. But unsecured loans offer more options, which makes it generally easier to get a loan.
There are different types of unsecured loans and a wide range of entities that can offer this type of loan, like banks, online lenders, and credit unions, among others.
Cons of Unsecured Loans
Bad for Credit Scores
Due to the increased risk, unsecured loans have a higher impact on credit scores.
The presence of an unsecured loan account in your credit report is enough for lenders to look at you as a higher risk, never mind actually defaulting on the loan.
When someone defaults on an unsecured loan, the standard practice on the part of the lender is to sell the uncollectible balance to one or more debt collection agencies.
Collecting payment then becomes the problem of these often aggressive and unscrupulous agencies.
If you ever default on an unsecured loan, do not be surprised if you’re to get sued by an unfamiliar company in the future.
High Interest Rates
Even with a sterling credit score, unsecured loans will have higher interest rates than comparable secured loans.
In fact, most unsecured loans come with exorbitant interest rates. Even worse if the borrower has bad credit. You can blame it on the riskier nature of these loans.
Should You Do It?
Applying for an unsecured loan is a matter of risk vs. reward. It’s often a situational choice that depends on the financial position of the borrower.