Unsecured personal loans are not backed with collateral. The borrower is promising to pay the loan without offering an asset as a collateral. If the lender has to approve an unsecured personal loan, then the borrower must have a good credit score. Secured loans include things like purchases through credit card, education loans and personal loans. Here the lender is taking more risk while approving the loan as they do not have any property or asset to recover in the event the borrower defaults. If your unsecured loan application is rejected, you can still avail a secured loan provided that you have an asset that can be used as a collateral.
The lender approves unsecured loans based on the following criteria:
- Borrower’s income:
The monthly payment should not exceed more than 30% of his income. Based on the borrower’s income the lender will set a limit that the borrower can repay comfortably without reducing his monthly income by a lot.
- Borrower’s profession:
If the borrower is employed, then the lender will check how long a company has employed him. The lender just wants to ensure that the borrower has a steady and provable income.
- Credit score and history:
Lenders will look into the borrower’s credit score and history as soon as they meet the basic criteria. The lender will want to see how the borrower has dealt with debt in the past. The credit history also contains details of the EMIs he is paying and the loans that he has cleared. It will also contain details of the times that the borrower has defaulted on the payments and if he has settled a loan. Only when the borrower’s credit score and history is convincing enough for the lender, the loan is approved.
Advantages of Unsecured Personal Loans
The advantages of unsecured personal loans are as follows:
- It is easily available to any person.
- You need not have a collateral to avail this loan.
- You need not state the purpose for which you are taking the loan.
- The loan can be repaid at your convenience and at the term set by you.
- Property is not at any risk. If you default on a Secured Loan, there is a chance that the lender will take possession of the asset you kept as a collateral. Since unsecured personal loan doesn’t need a collateral, there is no risk to your asset or property.
- The application process is simpler as the decision to approve an unsecured personal loan depends on the borrower’s credit score and credit history and his income.
Disadvantages of Unsecured Personal Loans
The disadvantages are as follows:
- Since the lender is taking a higher risk, the interest rate is higher.
- The loan amount that is sanctioned is limited as there is no security provided so that the lender can recover the loan amount.
- The loans are provided for a shorter period. The payment period of unsecured personal loans range from 3 – 4 years. This is also another factor for the loan amount to be limited.
- Credit card debts can lead to more debt if you are not in a position to pay off the outstanding balance each month.
- Unsecured personal loans look bad on your credit report. You need to ensure that you have enough secured loans as well. It will seem like you have managed to build only debt and no asset over the years.
Be very careful with unsecured loans. Repay them at the earliest and find alternative methods as much as you possibly can to finance your requirements. Most of the times, you might not really need the loan. If you wish to take a vacation save up for it by spending less on your luxuries. Take an unsecured loan only when you do not have enough equity.