Introduction and types

Loans that are not backed by any collateral are called unsecured loans and are also known as personal or signature loans. They are exclusively given on the borrower’s credit history and rating and, therefore, are difficult to get when compared to secured loans that take the borrower’s income into account before sanctioning it. Unsecured loans are easy to get but the borrower pays higher interest than the secured loans.

You can obtain unsecured loans from a friend without any collateral, solely based on you friendship, or you can try it at financial institutions, largely based on your credit history which is strictly a business transaction, and your good-name, reflecting you past credit repayment performance, is at stake for your present and future borrowings. Unsecured loans can be of three types. In unsecured business loans the business is responsible for repayment. Personal loans require individual for repayment. And, in unsecured business loans with personal guarantee the individual is responsible for loan repayment.

Lending decision criteria and determination of interest rate

The situation for the lender becomes troublesome if the borrower does not, willingly or unwillingly, repays the loan because unsecured loans are not provided against any collateral. Compared to secured loans, unsecured loans have sterner guarantee rules, since it entails greater risk of loss to the lender. The borrower’s credit repayment performance, present and past, is taken into consideration by the lender. The lender’s decision to give a loan is largely decided by the borrower’s credit score and in the face of a bad credit history the lender may not decide to entertain the borrower’s demand for credit.

The lender weighs his risk against the borrower’s creditworthiness. The rate of interest or the annual percentage rate (APR), if the lender decides to give loan, generally takes into account two factors – the amount of the loan and the degree of risk. High amount of loans requires lower APR and high degree of risk will demand higher APR.

Versus Secured Loan

There is big difference between secured and unsecured loans, and both have merits and demerits, but one thing remains same that they put the borrowers in a difficult stand. On contrary to the unsecured loans, secured loans are the most popular and accepted means of borrowing money, especially large sums.

As against the unsecured loans, secured loans are given against some collateral like land, house, vehicles, etc., which provides the lender their partial ownership, which means in case of default – if the borrower fails to repay the debt – the institution or party lending the money will take-over the possession. Due to this, the secured loans are not very popular between people who think that it is bad-deal to offer collateral and loose them in case of delays in the repayment; however, some institutions have provisions to extend the repayment date. But on the good side, secured loans give you an option of co-signing the debt in the face you are unable to repay it. Moreover, secured loans involve a lower rate of interest.