What is an unsecured loan?

An unsecured loan is money borrowed from one party to another without any collateral to guarantee repayment. In most cases, these types of loans are considered high risk, as the lender typically has no way of forcing the borrower to comply with terms or make timely payments before legal action. For this reason, most unsecured loans have relatively high interest rates and are generally only available to those with strong credit scores.

Reasons to get an unsecured loan

Unsecured loans are mostly used for small short term expenses like medical crises or wedding or funeral expenses. They typically need to be paid off in about a year, although terms can vary depending on the amount involved and the relationship between the creditor and debtor. When borrowers don't have many valuable assets, seeking out an unsecured loan may be one of the only ways to gain access to needed funds.

Simplicity is another reason to look for an unsecured loan. When only small amounts of money are at stake, it is generally not worthwhile to transfer title to ownership and establish an escrow relationship. Often, a simple contract can be the best way to proceed, even if there are other trade-offs.

Bank loans

Bank customers often apply for unsecured loans as a way to get quick access to cash. Unlike home loans or car loans, which are typically secured by the house or car, unsecured loans are simply made at the borrower's word to repay. There are always contracts to sign and documents to process, but there is nothing the bank can accept if the borrower defaults on the borrowed money. This type of unsecured loan can also be called a "signature loan".

Banks generally do not grant unsecured loans to anyone. A client generally must have a stable income, as well as a timely and reliable payment history, to be considered.

Unsecured personal loans

Most loans between family and friends are unsecured. These types of loans are often very informal and may not be documented in writing. The parties usually come to an agreement on when and how the money will be paid, but this is often unenforceable.

credit card transactions

Purchases made with credit cards are often structured as unsecured loans. Credit card companies extend a certain line of credit, guaranteed only by the customer's contract, to pay for purchases. Failure to pay usually leads to high fees and interest, but not the seizure of assets. The attachment of assets occurs as a result of a court order, usually issued to remedy the chronic lack of restitution, and not because the asset is a guarantee.

Interest considerations

High interest rates are one of the features of almost all unsecured loans. By charging higher-than-usual fees, creditors can protect themselves against the risk of default. Most of the time, banks offer more competitive interest rates than credit card companies, but not always. Borrowers are generally wise to carefully research all options and terms before committing to a specific loan.

tax consequences

At least in the United States, people who have secured loans, such as home loans where the house serves as collateral, can often deduct any interest charged on their tax returns. This almost never applies to interest on an unsecured deal.