What is an unsecured loan?
Unsecured loans are a model of financing where no collateral is required by the lender or submitted by the borrower. In some cases, a guarantor is required or the lender can be placed under the liability of court action and judgment in the event of default. Either way, the only direct liability on the lender is the repayment of the loan and the interest rate that applies to the loan.
While it may not be difficult to find an unsecured bad credit loan company that will lend you money without asking for collateral, most don’t understand that the requirements for approval are much more stringent with unsecured loans. People also don’t understand the repercussions of defaulting on such loans and willingly opt for them just on the understanding that they don’t have to risk any personal assets in the process.
This article will detail the advantages and disadvantages of unsecured loans which will eventually help you in determining the value of such an arrangement to your needs and whether it is a good idea to enter into such an arrangement in the first place.
The biggest advantage of unsecured loans is the fact that no collateral or security is needed. You don’t need to worry about arranging money to put down as cash collateral or risk your personal valuable possessions as security for financing. This way, you won’t be losing out on any material possessions if you were to default on your payments.
There’s also the convenience factor which basically only consists of fast approval times. In most cases, you will only need to fill out a form online and wait for a few days, if not hours, before the money is deposited into your account. The fast and convenient processing means dealing with fewer people and spend less time on fulfilling formalities.
This is where the advantages end though. As you keep reading, you will soon see that unsecured loans are not the best option, especially when you consider the flip side and study the disadvantages associated with unsecured loans.
Disadvantages of unsecured loans
No collateral does indeed mean that you eliminate the risk of having your personal property seized by the lender, but that does not mean there are no repercussions of defaulting on your payments. If you were to default, the hit your credit score would take would be almost too hard to overcome. What’s more, is that the lender will still have the right to file a lawsuit against you and ask a court of law for recovery.
Considering that a court of law’s judgment is binding, a court could direct you to give up possessions as collateral until such time as you have paid the lender in full. If the lender is feeling hostile, they could also apply for damages in addition to the recovery amount and you’ll end up having to pay a lot more than just the borrowed amount and interest. If the court places a time limit on your repayment and you fail to make the payment, you could end up losing your possessions irrevocably and then still have to pay the outstanding amounts.
Also, just because one requirement (of collateral or security) is no longer applicable, that does not mean that all other requirements are waived off as well. You still need an excellent credit history in order to qualify for an unsecured loan. In the United States, you need a FICO score of 740 or more just to have your application considered for approval. Therefore, bad credit would automatically disqualify you from availing such a facility.
You also need to have a steady employment history and a well-paying job as these are indicators of your ability to pay back the money you’ve borrowed. With a shaky work history and low salary, you would have much more difficulty being able to pay the loan, from a financial standpoint alone, which would cause the lender to reject your application.
Even if you were to qualify for an unsecured loan, the interest rates you would have to pay would make you reconsider the entire exercise. Some lenders go as far as charging 65% interest per annum meaning you would have to pay £650 on a £1000 unsecured loan. Add to the high-interest rate the fact that unsecured loans tend to be for short term financing only, with most arrangements not going beyond the two-year limit. This leads to a larger monthly repayment amount.
If we continue to use the £1000 example, a two-year loan would accrue an interest of £1300 over two years which bring your total amount owed to £2300 (against a £1000 loan!) with a repayment schedule of two years consisting of monthly repayment of almost £200. Do unsecured loans still seem worth it? Oh, and you can’t even borrow a large amount of money as unsecured loans are usually for small amounts only.
As you can see from the above, the risks associated with unsecured loans effectively render them an ineffective form of financing. Not only is the risk high, but the adverse impact of default also makes the entire arrangement very unappealing. Situations may be dire at times but that does not mean you throw all reason and prudence out the window.
There are several alternative forms of financing available that you could opt for if you’re looking for a short term loan. Secured personal loans can offer you a fast financing solution without having too many restrictions in place. You would have more money available to you at lower interest rates over longer periods of time. This not only makes the loan more manageable but the reduced risk and lower adverse impact on your credit rating allows for more room to recover even if you were to default.
At the end of the day your personal circumstances, money problems, and savings advice you’re your consultants (if any) would decide what financing option you should go for. However, it doesn’t hurt to consider all your options!