Lenders often require borrowers to put up collateral before they can approve a loan. These are known as secured loans. Unsecured loans, on the other hand, are not secured by any collateral.
Before borrowing money, you need to decide whether you want to take out an unsecured loan. Here are some advantages and disadvantages that you will need to consider before submitting a loan application.
Advantages of unsecured loans
Here are some of the key advantages of unsecured loans.
Your personal property will not be at risk
When you take out an unsecured loan, the lender cannot repossess your home, car or other property if you default on your payments. You may face other repercussions, but your property will remain safe.
You don’t need to file as much paperwork
Applying for a secured loan requires mountains of paperwork. You need to provide proof of ownership of the property you are using as collateral. Many of these forms need to be notarized. You also need to state that you are willing to surrender your property if you don’t meet the terms of the agreement.
You have more flexibility with spending your money
Secured loans typically have stricter provisions on how you can spend the money. Fortunately, when you take out an unsecured loan, you will have much more flexibility. You won’t need to get a waiver from the lender if you change your mind and decide to use the money for other expenditures.
The payment terms are easier to follow
Unsecured loans are loans of a personal nature. The payment terms tend to be much clearer, so you don’t have to worry as much about penalties for breaking them.
Disadvantages of unsecured loans
There also some disadvantages of unsecured loans as well.
You Will pay a higher interest rate
Interest rates are determined by the risk that the borrower will default. Lenders face a higher risk with unsecured loans, because they can’t use the borrower’s collateral to offset the loss of a default. They have to offset this risk by charging higher interest rates for unsecured loans. The average interest rate on an unsecured loan for a borrower with good credit is between 13.5% and 15.5%.
You will receive a smaller loan
Since unsecured loans aren’t backed by collateral, lenders will have a harder time recovering it in the event of a default. They must mitigate their loss by offering smaller loans to their borrowers.
There is a lower chance that your loan will be approved
Lenders are taking a greater risk by offering an unsecured loan. Since you aren’t offering collateral to back it up, you must exceed their other actuarial requirements. All other factors being equal, your chances of being approved for an unsecured loan are lower than being approved for one that is backed by collateral.
Unsecured loans charge higher interest rates for some peace of mind
If you are concerned about protecting your personal property from seizure, you may want to consider taking out an unsecured loan instead of a traditional secured one. Just keep in mind that you will be charged a higher interest rates and probably receive a smaller sum. You will need to decide whether it is worth the trade-off.