Unsecured Credit Loan

The major difference between an unsecured credit loan and secured credit loan is the use of collateral. Secured financing is based on collateral, a tangible asset that lowers the risk for the lender. Two common examples of secured financing are home mortgages and automobile financing. When house payments are missed, the mortgage holder may begin foreclosure proceedings against the homeowners. When car payments are missed, the financing company may repossess the vehicle. With the ability to reclaim tangible assets like these, the lender has the opportunity to recoup at least a percentage of the borrowed funds. Additionally, most people have a strong aversion to having their homes sold out from under them or having their vehicles repossessed. Therefore, borrowers have a powerful incentive to keep up with the monthly payments. An unsecured credit loan is not based on collateral, but on information that the prospective borrower enters on the lending institution's application.

Two other differences between a secured and unsecured credit loan are the lender's level of risk and the interest rate that the lender will charge the borrower. In the financing industry, these two factors correlate to one another and to the use or non-use of collateral. Obviously, the lack of collateral increases the risk for the lender that the borrowed money may not be repaid. Should the borrower miss payments, the unsecured lender doesn't have a house to foreclose on or a vehicle to repossess. Instead, the lender has to resort to threatening letters and phone calls, turning the account over to a collection agency, and/or getting assistance through court system. There are laws that creditors must observe when trying to collect on an unpaid debt. Consumers who are receiving calls and letters from creditors or collection agencies are advised to familiarize themselves with the provisions of the Fair Debt Collection Practices Act. Because of the increased risk of not having collateral to secure the debt, the interest rate on an unsecured credit loan will almost always be higher than the interest rate on an "all other factors being equal" secured loan. A higher interest rate equates to higher monthly payments to repay the debt. However, the monthly payment can be reduced by lengthening the number of months that the funds need to be repaid.

An unsecured credit loan is sometimes known as a signature loan because it is based on the strength of the applicant's signature -- in other words, her reputation for meeting monthly obligations. A credit card account can also be considered as a type of unsecured financing. These are common types of loans in many households. However, there is another type of unsecured financing that can quickly spiral out-of-control even for financially-conscientious people. More commonly known as payday advance loans, these lenders charge fees that calculate to extremely high annual percentage rates. The Bible warns against charging high interest rates to people in need in this verse: "He that by usury and unjust gain increaseth his substance, he shall gather it for him that will pity the poor" (Proverbs 28:8). Though such a harsh admonition isn't given for those who pay usurious rates, it's unwise to get caught up in a financing situation with a high APR. In recent years, legislation has been passed in many states to limit the amount of interest that a payday lender can charge. However, borrowers should still beware of borrowing money through a payday advance company. This type of unsecured credit loan should only be used as a last resort.

In general, financial institutions require less paperwork and documentation on unsecured loans than they do on secured financing. Anyone who has filled out an application for a credit card knows how short the application is and how quickly it can be approved. But applying for a home mortgage, home equity line of credit, automobile financing, or another type of secured loan can mean providing all kinds of paperwork to the lender. For this reason, sometimes it is quicker and more convenient to apply for an unsecured credit loan than to go through the hassle of making copies of income tax statements, pay stubs, and other required documentation. However, for the vast majority of people, the highest amount that can be borrowed through unsecured financing will only be a few thousand dollars. People with poor credit histories may qualify for loans amounting to only a few hundred dollars.

Financial institutions will have differing criteria for determining whether or not to approve a prospective borrower's application. Whether or not the applicant is applying for a secured or unsecured credit loan, one important factor will be the applicant's FICO score. A higher score reflects a history of meeting financial obligations as well as residential and employment stability. An applicant with a higher FICO score will most likely be able to obtain financing with more favorable interest rates than someone with a lower score. In addition, the higher score may qualify the applicant to borrow more money than someone with a lower score. Individuals are advised to obtain their FICO scores and copies of credit reports before applying for any type of financing. A free report can be obtained from each of the three major credit reporting agencies once a year. Consumers are advised by financial experts to obtain the free reports on a regular basis so that the reports can be reviewed for accuracy. There will almost always be a small fee to obtain the FICO score, but it is worth the small price to have this information before applying for financing.

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