What is an Unsecured Loan?Published on May 21, 2021 by Daniel Azzoli
When you run into an emergency expense, what do you do? Do you ignore the problem and hope it goes away? Do you wait and wait until you finally have enough money to pay it off? Well, when you’re face to face with an unexpected expense you can’t afford, it might feel like you don’t have a ton of options at your disposal. The problem is, doing either of the things we just outlined can be a one-way ticket to a bigger problem. The more you ignore your emergency, the worse it may get, and the more it’ll likely cost you to fix.
But if your savings have run dry and you feel like you have nowhere to turn, there may still be ways to secure some extra funds to help you through this tough time. One of these potential options is to apply for an unsecured personal loan.
Before you apply for any type of loan, you need to understand the product you’re applying for and know what you’re getting yourself into. This means you’ll have to sit down, roll up your sleeves and do some research. To help you get started on the right foot, we’re going to go over what unsecured loans are, break down some of their important details, and walk you through some of the different types of unsecured loans out there.
What is an Unsecured Loan?
Unsecured loans are a very broad category of personal loans. You can apply for one from different places, such as banks, brick-and-mortar lenders, credit unions, or online lenders. While there are plenty of different types of loans that could fall under this umbrella, our main focus today will be on short-term personal loans like lines of credit, installment loans, and more.
Differences Between Secured and Unsecured Loans
One of the best ways to get a clearer picture of unsecured loans is to understand how they differ from secured loans. So, what’s the main difference? Well, we’ll need to start by taking a look at what’s required to qualify for each category of loan.
With a secured loan, you’ll need to provide collateral in order to qualify. Collateral comes in the form of some sort of valuable asset that you agree to give to the financial institution if you end up defaulting.
If you need a more specific example, we can look to two common types of loans – mortgages and auto loans. These are both secured loans that require you to put up collateral in order to qualify. In the case of a mortgage, the collateral comes in the form of your equity in the house you’re buying with the mortgage. With an auto loan, your collateral will typically be the car you’re buying. In both cases, if you continually miss your loan payments, the financial institution will be able to claim the assets you’ve put up as collateral.
So, why risk losing an asset to secure a loan? Well, because the financial institution has some assurance that they’ll get something of value out of the interaction – whether it be your scheduled loan payments or the collateral you’ve put up – these loans generally come with relatively low interest rates.
With unsecured loans, you won’t be required to put up any assets to qualify. Instead, the financial institution will look more closely at certain areas of your financial profile to determine what type of borrower you’re likely to be.
For starters, they may pay close attention to your credit score. This three-digit number is determined by different credit scoring models, like FICO, in order to synthesize your financial profile into a simple score to help lenders make decisions. They’ll also likely require you to show proof of employment, proof of income, and certain other pieces of personal information.
If you’re worried that your credit score won’t be strong enough to be approved for an unsecured loan, there may be other options out there for you. There are some financial institutions that specifically offer unsecured loans for bad credit. Instead of placing a lot of emphasis on your credit history, they generally focus more on some of the other details we mentioned. These loans may be offered by both online lenders and storefront lenders.
Keep in mind that with these loans, such as unsecured loans online for bad credit, you’ll generally be faced with higher rates. For this reason, these loans should only be used in emergency situations when you have no other options.
3 Different Types of Unsecured Loans
Like we said, an unsecured loan is really an umbrella under which a few different types of loans can fall. So if you’re facing an emergency expense and you’re looking for something to suit your situation, there may be different options available to you. While some of the types of loans on this list are also considered to be broad categories of loans, this should give you some idea of what’s out there.
1. An Unsecured Installment Loan
An unsecured installment loan is a fairly standard type of financial product that comes in the form of a lump sum. If approved, you’ll be required to pay back the loan with interest and/or fees over the course of several pre-determined, scheduled payments. The amount of time you have to pay back what you owe can vary based on a number of different factors, like the type of installment loan, the financial institution providing the loan, and more.
There are certain characteristics of unsecured installment loans that can make them useful options in an emergency situation. First off, the fact that your payments are spread out over a relatively lengthy time period might make them more manageable. On top of that, the fact that you can see how much your payments are going to be and when they’re due ahead of time may make it easier for you to incorporate them into your budget in advance.
2. An Unsecured Line of Credit
Unlike an installment loan where you’ll get your money in the form of a lump sum, with an unsecured line of credit, you’ll be approved for a specific credit limit that you can draw funds from on a continuous basis. As long as you have available credit and your account remains in good standing, you should typically be able to access funds without having to apply for a new loan (although there are some exceptions to this depending on the financial institution you’re working with).
If you’re looking to have a safety net in place to help you in times of emergency, an unsecured line of credit can be a flexible option. You can draw available funds when you need them, and you can choose how much to draw based on the cost of your emergency expense.
To add to their level of flexibility, in a lot of cases, you may have the option of making a minimum payment. This payment will be a small portion of what you owe, and by choosing this option, you can keep your account in good standing while not making your full payment. This can be a huge help when you find yourself unable to make your full payment but don’t want to be dinged for missing it. Having said that, you should try not to make a habit of only paying the minimum. Do your best to pay as much as you can to avoid extending the total amount of interest you end up paying.
3. Credit Cards
Did you know that your credit card is also considered to be a type of unsecured loan? If you need some financial help in an emergency, this can also be another useful option to have at your disposal. Just keep in mind that the cost of missing a credit card payment is steep, as they usually come with high interest rates. These steep payments could lead you further into debt, so make sure to only use your credit card when you know you’ll be able to make your payments on time.
You might also want to consider using the cash advance feature that may be available to you through your credit card. But this is a fairly expensive credit option, and interest will start to build up immediately on the money you take out, so treat this as a last resort to be used only for emergencies.
An Unsecured Loan Could be One Solution to Your Short-Term Cash Flow Problems
The road to manage an emergency expense isn’t always a straight path. With everyone’s financial situation being different, there isn’t always an obvious answer to your cash flow problems. But that doesn’t mean that there isn’t a solution out there for you.
With all of the financial products on the market, there may be an unsecured loan that could be the short-term answer to your emergency expense. Just remember to do your research, compare and contrast all of your options, and look for the best fit for your finances!