Vanta Unstructured Loans

How Do Unsecured Loans Work?

With secured loans, the borrower puts up an asset of some sort to act as collateral, ensuring that they will either pay back the loan or give up that asset. The asset being pledged provides “security” — thus a secured loan. Car loans and mortgages are common secured loans that many people will encounter throughout their lives. 

Because unsecured loans are not backed by any assets, they tend to put more risk on lenders. As such, unsecured loans also usually carry interest rates that are higher than secured loans. Credit score requirements for unsecured loans also tend to be much higher. 

If a loan applicant does not have a high enough credit score or a deep enough credit history, sometimes a lender will allow them to bring in a cosigner for the unsecured loan. In this case, the cosigner must promise to pay the debt if the borrower is unable to in the future. When a borrower cannot pay principal loan payments and interest, it is known as “defaulting.” If a loan has a cosigner, they take on responsibility for the payments when the borrower defaults. 

• They are not supported by any form of collateral, but rather by the creditworthiness of the borrower as determined by credit score.
• They are also called signature or personal loans.
• They require higher than normal credit scores and usually carry high interest rates because they place more risk on lenders.

Common examples of unsecured loans include student loans, personal loans, and credit cards. These unsecured loans generally come in two different forms: term loans and revolving loans. 

Revolving loans are most commonly associated with credit cards or lines of credit. With this type of loan, there’s a set credit limit. The borrower can spend up to that limit, repay what they’ve spent, and then spend it again, in a cycle. Thus, revolving. 

On the other hand, a term loan is a single set amount that the borrower agrees to pay off in equal portions until it is paid off in full. Once it has been paid off, no further credit is extended and no further payments are needed. Terms loans are usually secured loans, but they can be unsecured as well. For example, a bank signature loan or a consolidation loan that’s meant to help pay off credit card debt would be unsecured term loans. 

According to many recent reports, unsecured loans are becoming increasingly popular thanks to improved financial technology. Credit reporting agency TransUnion predicted in late 2018 that credit card balances would increase by nearly five percent in 2019, topping out at $840 billion. TransUnion also projected a huge 20 percent increase in personal loans to over $150 billion by 2019’s conclusion. 

New online and mobile lending services have contributed to an intense increase in unsecured loans. According to TransUnion, financial technology firms (“fintechs”) accounted for just five percent of all the unsecured personal loan balance in 2013. By 2018, those same firms were responsible for 38 percent of all unsecured loan balance. 

Payday lenders and other companies that provide cash advances are not offering secured loans, at least not in the traditional sense. Payday loans technically do not require tangible collateral in the way that, for example, a car loan or a mortgage would, but payday loan lenders still secure their loans via alternate measures. 

Most commonly, a payday lender will either require that the borrower provide the necessary information to set up automatic checking account withdrawal, or they will ask for a check that is postdated. Online cash advance services will often require the borrower to use a payment service like PayPal, which helps ensure repayment. Loans such as these are considered unsecured, but these methods have more security than a traditional unsecured loan. 

Secured loans have a fairly standard and simple process for default; when the borrower defaults, the lender takes whatever was put up as collateral (the car, the house, etc.) to help repay its lost money. With an unsecured loan, there is no property or other collateral for the lender to seize in the event of a default. 

Lenders are not completely without recourse in these situations, however. They can take the borrower to court or work with a collection agency to try to hunt down what they’re owed. Even if a borrower does not have the money to pay back the lender immediately, a court could order that the borrower’s paychecks are garnished — essentially forcing the borrower’s employer to withhold a certain amount from every paycheck to give to the lender instead. Courts can even go so far as to place a lien on a borrower’s home or other property, essentially creating collateral that was not part of the loan before.