What Is the Meaning of an Unsecured Loan?

When trying to borrow funds, you can choose to apply for either a secured or unsecured loan. It's important to learn more about unsecured loans and whether this is a smart choice for your own financial needs. Some lenders specialize in unsecured borrowing, but note that it is sometimes more difficult to get approved for this type of loan.

Definition

A secured loan is one that has an asset backing the borrowed funds, like a car or home loan. An unsecured loan is the exact opposite---the lender offers funds to the consumer without the presence of an asset to secure the loan. This means that in case of a default on the loan, the lender cannot repossess an item from the borrower, such as a home or car. An unsecured loan is a very risky proposition for a bank.

Types

Credit cards are one of the most common types of unsecured loans. The credit card company issues a credit line that the borrower can use without requiring collateral or property. Another type of unsecured loan is a commercial or business line of credit. The bank issues money for the company to use for business needs. However, in some cases, the lender may ask for collateral for a business loan. Though rare, some banks also offer standard unsecured personal loans (payable in equal installments) to consumers.

Benefits

One of the key benefits of an unsecured loan is that the borrower does not have to worry about losing property if the creditor puts the account into default status. He can simply access the funds for his needs while holding onto his assets. Applying for an unsecured loan is also usually a more simple process for a borrower compared to a secured loan since he does not have to provide detailed information about a piece of property. In some cases, the borrower must also get an appraisal to prove the worth of a piece of property for a secured loan---this isn't necessary for an unsecured loan.

Downside

Getting an unsecured loan also comes with one significant downside. For one, unsecured loans often come at a higher interest rate compared to secured loan. Lenders determine the rate for loans based on risk --- the higher the risk the higher the rate and vice versa. So due to the elevated risk that comes with approving an unsecured loan the rate is usually higher than other types of loans.