Unsecured Loans Usually Include Sky High Interest Rates
When shopping for a loan, borrowers typically have to choose between unsecured loans and secured loans. Secured loans are backed by one or more assets that the lender can seize and sell to recover at least part of the loan if the borrower defaults. Unsecured loans do not require collateral, but these types of loans can carry extremely high interest rates.
Why Unsecured Loans Charge Higher Interest Rates
If a borrower has collateral that he or she can use to secure a loan, the lender can feel more confident that the loan will be repaid. A mortgage is a type of secured loan; the home is the collateral, and if the borrower does not make payments, the lender can foreclose and sell the house to recoup all or most of the money owed.
An auto loan is another type of secured loan; the lender can repossess the vehicle if the borrower does not make payments. Most store-issued credit cards are a type of secured loan. For example, if a borrower uses a store card to purchase a new refrigerator, the store could repossess it if payments are not made.
With unsecured loans, borrowers do not have an asset that the lender could seize to recoup losses if the borrower does not pay. It is possible for a lender to sue a borrower and obtain a favorable judgment, according to NerdWallet.com, but this makes it more difficult for the lender to recover the money owed. A major exception occurs in the case of federal student loans.
Borrowers who default on student loans guaranteed by the federal government can be subject to wage garnishment or have their tax refunds applied to their student loans. For other types of unsecured debt, however, the legal process hampers the lender’s ability to collect in a timely manner.
Therefore, loans without collateral are riskier for lenders. As explained by Matthew D. Diette of the Federal Reserve Bank of Minneapolis, many traditional lenders rely on risk-based pricing to determine the rates that they will charge for a loan. As risks increase, interest rates follow suit.
One factor that lenders use to determine risk is the borrower’s credit history, which is why unsecured bad credit loans will carry higher interest rates than loans for the same amount made to borrowers with excellent credit. There can also be a substantial difference in the interest rates if the same borrowers have both unsecured bad credit loans and secured bad credit loans.
Lenders have found that collateral decreases the risk of default. After all, most people do not want to lose their home, car or other assets due to their failure to repay the loan. Furthermore, as the value of the collateral increases, the lender’s risk decreases.
After all risk factors are assessed, lenders decide on the appropriate interest rate to charge. A borrower with excellent credit and collateral will pay less than a borrower with excellent credit and no collateral. A borrower with poor credit and collateral will pay more than a borrower with the same collateral and excellent credit. However, unsecured bad credit loans typically carry the highest interest rates among all types of personal loans.
Are Loans Without Collateral Available for People with Poor Credit?
There are many lenders who offer unsecured poor credit loans. However, whether borrowers are seeking loans without collateral, credit cards, mortgages or car loans, more lenders are willing to deal with people who have good credit than are willing to loan money to people with impaired credit.
Furthermore, more lenders are willing to make secured loans than unsecured loans, and since the underwriting process is essentially the same regardless of the loan amount, lenders also prefer to make high-dollar loans. Few lenders, however, issue high-dollar unsecured loans.
What all of this means is that borrowers’ options are somewhat limited when it comes to unsecured bad credit loans. While these types of loans are certainly available, the choice of lenders may be restricted, the interest rates will be higher and the loan amounts will be relatively small.
Given the Negatives, Why Would People Choose Unsecured Bad Credit Loans?
In simple terms, the answer is that life happens. The car breaks down, a family member needs medical treatment or a pipe in the home freezes. Perhaps one of the family’s wage earners has his or her work hours temporarily reduced.
There are many reasons for borrowers to find themselves without the cash necessary to handle an unexpected expense and still buy food, pay rent and keep the utilities from being disconnected. If they have no assets that they can pledge as collateral, unsecured loans may be their best or only solution.
However, according to Bankrate.com, even borrowers with assets often prefer loans without collateral. Some borrowers do not want to risk losing their assets if they have to default on the loan. Other borrowers simply do not want the additional stress that they might feel if they are worried that they could lose a valuable asset.
Furthermore, loans without collateral can typically be used for any legal purpose; secured loans usually require that borrowers only use the funds for a specific purchase. For example, borrowers cannot take out a secured loan to purchase a boat and then use the funds to take a vacation. Many times, borrowers never see the money from a secured loan; lenders remit the payments directly to the party providing the merchandise that the borrower desires.
There is also the opportunity for borrowers to improve their credit rating through unsecured bad credit loans. Most lenders report to at least one of the major credit bureaus, and many lenders report to all three. Securing loans without collateral and making timely payments can help those with weak or no credit build a history that will make it easier to obtain credit. This can result in more options and better terms.
How to Choose a Lender for Unsecured Loans
When it comes to credit, many borrowers fail to shop for the best lenders. This is especially true for borrowers with poor credit; they are often under pressure to obtain funding quickly, so they do not look for the best lender.
Lenders who offer unsecured loans do not all charge the same interest rates. They may offer different loan amounts, different term lengths and different approval times. Some may not report to any of the credit bureaus, while others report to all of the three major bureaus.
Borrowers should take the time to compare lenders before submitting a form. This allows them to make the best choice for their specific situation. For example, those with bad credit may want to choose a lender who reports to the credit bureaus, while those who need a specific amount of money can eliminate lenders who do not make loans in sufficient amounts. Doing a little comparison shopping and comparing options can help borrowers obtain the best unsecured loans.
To Learn More About Unsecured Loans
All credit products carry a certain amount of risk to both borrowers and lenders. However, the more you understand about the different credit options, the less risk you will incur. If you would like to learn more about unsecured loans and other credit products, visit the Personal Money Store.