Unsecured Loan – What Are They & How It Works
If you need funding for your next project, have unanticipated business expenses, or preparing for business expansion, unsecured loans help you get financing without pledging collateral like your business, home, or any other valuable business assets. These loans come with less demanding qualification and needs than secured loans, and some lenders offer same, or next-day financing. If a borrower defaults on the loan, the lender is left with few options to get paid outside of filing a lawsuit. Hence, you may be faced with higher rates and less favorable terms compared to secured loans.
We will explain you how unsecured loans work and let you decide if they’re a good fit for you.
What Are Unsecured Loans?
Unsecured loans are loans that do not need collateral or a security deposit to receive. With an unsecured loan, instead of pledging assets, borrowers qualify based on their credit history and income. Lenders do not have the right to take physical assets such as a business asset or home. If borrowers stop making payments on unsecured loans. You promise to repay, but you don’t back up that promise by pledging collateral.
Common types of unsecured loans include personal loans, lines of credit, and unsecured credit cards, both personal and business. Personal loans are available from banks, credit unions, and lenders (‘lenders’), and can be used for any purpose based on your needs. The majority of credit cards available are also unsecured. Even though you might not think of credit cards as loans, you borrow money when you spend with them. You can get these loans from a wide range of traditional lenders and the application process is often less rigorous than for secured loans.
How Unsecured Loans Work
Unsecured loans normally range from $10,000 to $400,000, which you can use for a variety of purposes. In general, annual percentage rates (APRs) range from about 6% to 36%, and loan terms often extend from two to seven years.
When applying for an unsecured loan, lenders check your borrowing history to see if you have successfully paid off loans in the past and determine your overall exposure to debt. Based on the information in your credit reports, a computer creates a credit score, which evaluates your creditworthiness.To get an unsecured loan, you will need to have a good credit score, generally over 680, however, lower scores are accepted on a case-by-case basis. If you have done minimal borrowing in the past or have bad credit because you have fallen on hard times in your past, it is possible to rebuild your credit over time. Consider taking steps to improve your credit score before applying for an unsecured loan. There are several great companies who offer credit repair services.
Lenders will also want to be sure that you have enough income to repay any new loans. When you apply for a loan, whether secured or unsecured, lenders will ask for proof of income. Then, they will evaluate how much of a burden your new loan payment will be relative to your monthly income including incremental income if loan proceeds increase revenue. They typically do this by calculating a debt-to-income ratio.
Many lenders offer prequalification so you can review loan options before undergoing a hard credit check or decide the best option before moving forward. Depending on the lender, prospective borrowers may be able to apply for multiple loan options including multiple credit cards to stack capital. And, because unsecured loans don’t require collateral, applicants don’t need to wait for an appraisal or otherwise demonstrate the value of any assets.
Once an unsecured loan is approved, personal loan funds are disbursed as a lump sum and interest begins to accrue on the entire loan amount. With unsecured credit cards and other business lines of credit, the borrower can use the funds on an as-needed basis and interest only accrues on the outstanding balance. Payments must be made monthly and are typically reported to the three major credit bureaus, though there is typically a grace period when reporting late payments. Business credit cards do not typically report to the major credit bureaus if the borrower is in good standing.
Unsecured Loans vs. Secured Loans
The basic difference between unsecured and secured loans is the need for collateral. When you apply for a secured loan, you must put up an asset—whether your business, receivables, home, other business assets, investments, or cash—to receive it. In case you default on the loan, the collateral can be used to pay the lender. Secured loans are commonly used with business mortgages and asset loans. If you take out a business mortgage or asset loan, the asset becomes the collateral. If you default on your payments, the lender can take sole possession of the business asset and resell it or liquidate, a process known as foreclosure.
In the case of unsecured loans, if a borrower defaults, lenders are limited to collection actions like wage garnishment.To limit their risk when extending unsecured loans, lenders often need a higher credit score to qualify or will charge a higher interest rate and reduce their term and risk exposure.
What Happens If You Default on an Unsecured Loan?
If you default on an unsecured loan, the lender will send your missed payments to a collection agency. This will result in collection calls and following continued nonpayment, may necessitate legal action to recoup the outstanding debt.
If such legal action succeeds, the lender may recoup the loan balance through wage garnishment. A lender may also place a lien on your home or other asset. What is more, the default will result in a significant drop in your credit score and will remain on your credit report up to seven years.
Types of Unsecured Loans
There are different types of unsecured loans that can be used for variety of purposes. These are the most common types of unsecured loans:
- Unsecured personal loans – Personal loans are most commonly unsecured, though some lenders offer secured options. You can use this type of unsecured loan for a range of business uses, including everything from unexpected repairs to inventory, business expansion, equipment, and payroll. Personal loans for business are a great source of capital for startups and business expansion.
- Lines of credit – If you are facing expenses that will be spread over an extended period, business renovations for example, or experience cyclical revenues, a line of credit lets you access funds on an as needed basis. And, while certain lines of credit are secured, many lenders offer unsecured options. Lines of credit will require a minimum time in business with stated income. Each lender will have slightly different requirements.
- Unsecured credit cards – Credit cards are a type of revolving loan that lets borrowers access a certain amount of spending power that must be paid down each month. Cash out options are generally offered with introductory 0% interest rates. While secured credit cards are available, most credit cards do not require collateral. Both personal and business credit cards are a great source of capital for startups and business expansion.
Pros of Unsecured Loans
- Borrowers don’t need to own a valuable business asset to qualify for an unsecured loan
- Lenders cannot directly seize collateral if a borrower defaults on an unsecured loan
- You can generally use unsecured loans for a wide variety of purposes
- The application process is less extensive than for secured loans because it doesn’t require an appraisal of collateral
Cons of Unsecured Loans
- Missed payments or default will have a negative impact on a borrower’s credit score
- Default may result in legal action and subsequent wage garnishments
- Due to the increased degree of risk, lenders often impose higher credit score requirements for unsecured loans than for secured loans
- Interest rates and terms are also likely to be less favorable, especially for applicants with a weaker credit history
Key Takeaways
- An unsecured loan is one that doesn’t need collateral or a security deposit to receive
- Unsecured loans come in three main forms: personal loan, lines of credit, and unsecured credit cards
- Some lenders offer unsecured loans and fund on the same or next day
- Unsecured loans generally come with higher interest rates for higher risk borrowers
- To get an unsecured loan, you will need to have a decent credit score, generally over 680, however, lower scores are acceptable on a case-by-case basis
Alpine Funding Solutionsoffer unsecured loans from $10,000 to $400,000. Contact us today to learn more about unsecured loans, credit repair, and a wide variety of other loan products to help your business.
