The 7 Deadly Truths about Unsecured Loans

Man contemplates unsecured loans

Unsecured loans carry a number of features that may not be in your best interests.

There are two basic types of debt: secured and unsecured loans. As the name implies, secured debts are secured by an asset that the lender can claim if you fail to repay the debt. If you take out a mortgage or finance a new car, you have incurred a secured loan.

Should you fail to make your mortgage payments, the lender can foreclose, take possession of your home and sell it to recover the money that you still owe; in most cases, all proceeds from the sale go to the lender. If you do not make your car payments, the lender can repossess the car and sell it, keeping all funds generated by the sale.

Unsecured debts are those that are not secured by an asset; these include credit card debts and personal loans. If you default on unsecured debts, the lender has fewer options to recover the loss. Although this may sound comforting, there are seven ugly truths about unsecured loans that you should consider before choosing them.

Seven Unpleasant Truths to Consider About Unsecured Loans

There are advantages and disadvantages to every type of credit, including unsecured loans with bad credit, credit card debt, unsecured loans with excellent credit, installment loans, and vehicle loans. Although there are numerous advantages to an unsecured loan, there are seven disadvantages that are worthy of your consideration.

1. Regardless of whether you choose a credit union, bank or online unsecured loans, the interest rate will be higher than the lender would charge you on a secured loan, according to Investopedia.com. Secured loans do not pose the same risks to the lender; if you default, the lender will have access to an asset that can be used to recover all or most of the money loaned. If the loan is unsecured, however, about all that the lender can do is turn your account over to a collection agency; the lender may also sue you, but unless there is quite a bit of money involved or you committed fraud, most lenders will simply write off the debt.

2. However, your assets could still be at risk if you default on an unsecured personal loan, according to SmartAsset.com. If the lender decides to sue you, he may be able to obtain a lien on your assets, requiring you to pay back the loan and possibly the court costs and the lender’s attorney fees.

3. Unsecured loans with bad credit can carry especially high interest rates. This is also related to the risks that the lender is taking. Most lenders believe that people with damaged credit have demonstrated that they have problems managing their financial affairs, so the lender assumes that loaning money to them is riskier than loaning money to someone with excellent credit.

4. The risk factor also affects the size of the loan that lenders are willing to make. As a rule, unsecured personal loan amounts are always smaller than secured loans due to the lack of collateral. However, unsecured loans with bad credit will virtually always be for lower amounts that the same type of loans to people with excellent or even good credit.

5. Loan terms tend to be substantially longer for secured loans. Unsecured loans must typically be repaid quickly, often in as little as 12 months, and loan terms seldom exceed three years. Depending on the amount that you borrow, your credit and other factors, the actual loan term could be significantly less.

6. Monthly payments are normally higher if the debt is unsecured. This is due to the interest rate charged and the relatively brief repayment term. Although this allows you to retire the debt faster, the higher payments could place a strain on your budget, so always make sure that you can manage the payments before committing to a loan.

7. Online unsecured loans, personal installment loans and credit cards all have the potential to affect your credit rating. According to TheNest.com, approximately 10 percent of your score is derived from the types of debt you have. If you have unsecured debt and no secured debt, your score could be negatively affected.

However, the same is true if you have only secured debt and no unsecured debt. Therefore, unsecured loans can be a benefit or a detriment. The key is to find the right balance between the different types of debt — and to make every payment on time. Your payment history is a major part of your credit score, but in addition to the types of debt, your score will also be based on the total amount that you owe all lenders and how long the accounts have been open.

Consider the Advantages of Online Unsecured Loans Also

Although there are some disadvantages to online loans, there are also some advantages. Submitting a request for a loan online is convenient; you can choose the time that is best for you, even if it is the middle of the night or a holiday. Most request forms can be completed in just a few minutes, so the process is fast. Decisions are typically fast as well; secured loans often require inspections or valuations of the asset that is being pledged as collateral, resulting in a delay of several days or even several weeks.

Is an Unsecured Loan Your Best Option?

No two borrowers are in identical situations. The type of credit product that is best for you depends on many factors, including your credit score, your budget and your income. You should also consider whether you have options that do not require you to take on more debt. For example, you might be able to postpone a purchase until you have saved enough to pay cash for it.

You might be able to borrow from your relatives or sell unwanted items to raise the cash you need. In the end, only you can decide which option is best for you. However, the more information you have, the better prepared you will be to choose the option that best suits your needs. If you would like to learn more about personal finance, unsecured loans with bad credit or similar topics, you can find a variety of helpful articles at the Personal Money Store.

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