If you need to borrow funds to consolidate loans and credit card debt, take a holiday or even fund a home improvement project, a personal loan will help you handle your bills without going broke.
Many personal loans are unsecured loans, meaning that they do not need collateral. Loan amounts range from $1,000 to over $50,000 and are repaid over loan terms as short as six months or as long as seven years.
The interest rate can be either fixed or variable, and will usually be higher than the rate for a secured loan because there is more risk for the lender.
The difference between secured and unsecured loans
A secured loan requires the borrower to allow the lender to place a charge over an asset owned by the lender, typically either a house or a car. The asset offered as security may be the asset being purchased with the loan funds – often the case with a secured car loan. If the lender defaults on the loan by failing to make repayments for a significant length of time, the lender can apply to the court for the right to take possession of the asset and sell it, in order to recover the outstanding loan amount and associated costs. Because of the security of the asset backing the loan (known as collateral) the lender will see a secured loan as less risky and is more likely to approve the loan application and offer a lower interest rate.
An unsecured loan does not require the borrower to provide any collateral. It is suitable for borrowers who do not have any substantial asset to offer as security, or who may own an asset but would prefer not to risk losing it. Lenders see unsecured loans as more risky, and are more likely to either refuse the application or demand a higher interest rate.
Qualifying for an unsecured loan
Because lenders see unsecured loans as more risky (because they're not secured by a borrower's asset) they can be more difficult to get approved for. Below are some of the things that lenders look at before determining whether you qualify for a loan, and at what cost.
- Credit score: Your credit history and score are vital considerations in the lending decision for most lenders. A very good credit score will allow you access to the lowest unsecured lending rates and the largest choice of loans. But applicants with bad credit scores will typically be offered much higher interest rates.
- Depth of credit history: Lenders consider the scope of your financial history, and many require borrowers to have a credit history of at least two years' duration. This can make it difficult to get an unsecured loan if you have never had a credit card or a previous loan, or if you're a recent migrant. But you still have the option of a secured loan.
- Debt-to-income ratio: Loan providers look at your debt-to-income ratio, which is your monthly debt repayment costs expressed as a percentage of your monthly income. This indicates how burdened you are by debt already. If you already have too much debt, there's a strong likelihood that you'll be unable to repay a new loan.
Alternatives to an unsecured personal loan
There are other options, besides an unsecured personal loan, if you need access to extra funds:
- Low interest credit card: The interest rate on a low-interest credit card may be higher than the rate for a low-interest personal loan, but it provides more repayment flexibility.
- Balance transfer credit card: Credit cards with a 0% interest promotional offer allow you to transfer balances from your existing credit cards (and in some cases from an existing personal loan) to your new card, and pay no interest charges for 6-12 months, sometimes longer.
- Secured personal loan: Having an asset to offer as collateral will give you access to lower interest rates.
