Rather than putting off a major life event like your wedding, honeymoon, education or home renovation, a personal loan can help you achieve these milestones sooner. And when it comes to sudden expenses like emergency home repairs or unexpected medical bills, personal loans can help you stay on top of things.
There are two types of personal loans – secured and unsecured. Choosing between the two is just a matter of deciding which one is right for you and your current financial situation. Read on to get a better understanding of unsecured personal loans, and how this choice could potentially help you.
The difference between unsecured and secured personal loans
To help you understand unsecured personal loans, we need to talk about secured personal loans first. To get a secured loan, a borrower must pledge an asset they own as collateral or security. In the event that the borrower is unable to finish paying their loan, the lender has the right to take legal action to repossess the asset. Car loans and home loans are two of the most common kinds of secured loans, with borrowers pledging their newly purchased vehicles and homes as security.
Conversely, unsecured personal loans require no such security. You simply take out a loan and promise to repay your lender the full loan amount within the set loan term. However, because lenders don't have any security, they need to offset some of the risk involved with lending out such a large sum of money. As a result, interest rates for unsecured loans are typically higher than the rates for secured ones. The maximum loan amount is also more likely to be lower than the average secured loan.
On top of this, lenders are also more stringent about borrowers' credit ratings. If you've got bad credit, you'll have a harder time pinning down an unsecured loan. Why? Think of your credit rating as a snapshot of your financial behaviour. A high score indicates that you pay your debts on time and aren't trigger-happy with your credit card, and that's the kind of person a lender can trust their money with. Check your credit rating before applying.
Types of unsecured loans
An unsecured personal loan can either come in the form of a term loan or a revolving loan. The former is characterised by a set loan amount to be paid over a set loan term. Usually, the borrower agrees to pay the loan amount in equal instalments until the amount is fully paid or the term has reached its end.
On the other hand, a revolving loan is more flexible. Instead of setting a fixed amount to be loaned, the lender sets a maximum amount that can be borrowed. The borrower can then dip into the revolving loan to borrow money whenever they need it, then repay their debts on an agreed schedule. If this sounds familiar, it's because this is how credit cards and personal lines of credit work. So in essence, a credit card is a type of unsecured loan.
There is another type of unsecured personal loan called a debt consolidation loan. When someone struggles to juggle too many debts at a time, they can make their lives easier by opting to consolidate their loans. That is, to roll all their loans into one account. In effect, they only have to repay one loan amount and one interest rate, as well as owe money to only one lender.
Cost of unsecured loans
While the higher interest rates for unsecured loans (because of the lender's higher risk) are a major factor to consider, you'll also want to take a careful look at the fees involved. Once again, the higher risk level may have an impact on the size of the fees, which can include:
- Application fee. While some lenders don't charge an application fee, others may charge a fee of between $50 and $500, or more. In most cases, however, this is more properly described as a loan establishment fee, and will be charged upfront once your loan is approved.
- Ongoing account administration fee. Account-keeping fees may be charged monthly (e.g. $10) or annually (e.g. $100), but once again, some loans may not have these fees.
- Late payment fee. If you fail to make your monthly repayment on time you could be charged a flat fee, typically around $20. Avoid this fee by setting up a direct debit from your bank transaction account to make your loan repayments.
- Early repayment fee or break fee. The interest rate you are given takes into account the profit the lender expects to make from the loan. If you repay the loan before the end of the agreed term, or make extra repayments, some lenders may charge a penalty fee to compensate for their lost profit.
The effective cost of some of these fees, but not necessarily all of them, may be included in the comparison interest rate, shown alongside the advertised interest rate.