Trust between lender and borrower, a vital factor for unsecured loans
Unlike other types of borrowing where the lender obtains money against some form of collateral, unsecured loans are the exact opposite. In this type of debt, you do not pledge any asset to act as security – your creditworthiness comes into question. Also referred to as personal or signature loans, approval depends solely on your credit score. Since the lender is taking a significant risk, you will notice that the interest rates are higher than say, a secured loan such as a mortgage. On the other hand, lenders also require that you have a higher credit score than you would for different modes of borrowing.
Forms of debt available
- Credit cards
A credit card is an unsecured mode of borrowing in the sense that the issuer allows you to tap into a pool of money. Interestingly, the lender does not give you the money you need as a lump sum. Instead, any time you need money, you just charge the amount to your card. However, there is a spending limit. Borrowing money through credit cards is easy. After getting your application approved, you can step into the nearest outlet and spend on the strength of your card.
- Signature loans
All it takes to obtain this debt is a notification to banks or credit unions. The loan amount comes as a lump sum but you pay in monthly installments. With good credit, you can obtain signature loans plus they attract low interest rates. To benefit in the future, you need to be disciplined by paying promptly as soon as the obligation falls due. If you diligently follow this approach, subsequent borrowing becomes easy and you get to enjoy reasonable rates.
- Peer-to-peer loans
These are usually online-based where you place a request to borrow and a group of individuals fund it. There are numerous lending sites where you can apply for a loan with bad credit under this arrangement. Usually, the funds come from investors who team up to lend people money. In return, they benefit from the interest charged. To qualify, you must visit a P2P website and create a profile. The site administrators display your information for review. Investors examine your information in comparison to the amount you have requested for and decide whether to lend or not.
- Student loans
To qualify for a student loan, you must show proof of enrolment to a college or university. Often, lenders work in conjunction with the finance departments of learning institutions. If you need one, visit your school’s finance office who will direct you accordingly. Bearing in mind your status, these unsecured personal loans come with some goodies such as a sufficient grace period and flexibility in payment.
- Payday loans
A payday loan helps you meet urgent financial obligations that pop up within the month, long after your payday. It is a short-term obligation that you should fully pay back within a month or less. Lenders expect you to repay as soon as you receive your next salary. You can issue a post-dated check or instruct your bank to do an electronic transfer to the lender’s account. The amount will be automatically deposited to their bank. If you fail to repay the loan as agreed, you can apply to roll over the credit to the following month. However, you will incur additional fees.
Are unsecured loans hard to get?
Securing a personal loan is not always easy. However, if you know where to start and the process to follow, you can fast-track the loan approval. Your credit history and background are the main qualifiers since there is no collateral required. That is why in some circles, you will hear of “good character loans”, meaning that lenders depend on a borrower’s reputation. Nonetheless, you need to show proof of income. Even if your credit history is not good, your credit union management team will still allow you to borrow. In the latter case, your salary by being in employment provides the backing you need. As you can see, obtaining an unsecured loan is not hard at all.
What is the basis for unsecured loans?
Since there is little or no backing for unsecured loans, interest rates will be higher than other types of debt. Remember the part we mentioned about the character? Well, your reputation comes into play here. If you have been a valued customer at the bank where you keep your money, the institution may consider your business relationship. They will assess among other things how often you make deposits, the balance in your bank account and whether you have borrowed from them in the past. All these factors will contribute towards your having the interest on your loan and monthly payments lowered.
Are unsecured loans long-term credit?
The best way to answer this query is by looking at what long term and short term refer. In a long-term debt, your obligation to pay back the principal plus interest lasts for more than one year. On the contrary, short-term debt is due for clearance in one year. While there are no restrictions to make unsecured loan repayments stretch beyond one year, the interest charged will often discourage you from taking it too far. Besides, lenders are at a high risk since they cannot attach any claim on your possessions.
Can you consolidate debt?
Time and again, financial difficulty may hit hard, leaving you with no option other than borrowing. But with borrowed cash, you must contend with inflation and high costs of debt. A long-term measure would be to seek for debt consolidation as a rescue package. What this means is that you take one large loan to finance all other debts. Typically, this package works with credit card debts where you have accumulated several of them. By merging your costs into one payment, the monthly payments reduce just as does the interest rate.
Consolidation also helps reduce the stress associated with payment deadlines from multiple creditors. By merging numerous lines of credit into one, you can benefit in the following ways:
- Reduced monthly payments
- Lower interest rates than what you were paying before
- Your credit rating remains high
- With discipline and focus, you can eliminate debt
How do you consolidate debt?
- Collate your debt
Compile all your loans on a spreadsheet. Have a column for type of debt (e.g. credit card, student loan), amount owed and interest on each loan. To obtain these figures accurately, you may have to check the contract documents you signed. You could also ask your lenders to confirm what you owe.
Review your spending plan by analyzing your income and comparing with your expenditure. Simulate your situation at the present and after consolidating debt. You may have to make some sacrifices by dropping off items you can live without.
You can consolidate debt through a settlement, management of what you owe or taking a blanket loan. Before you make a choice, think carefully through the benefits and cons of each.
- Stick with your plan
Always bear in mind that by combining your debts into one loan, the measure is not an immediate solution. You must give it time since it takes about three to five years before you can be free from debt. During this time, make a personal commitment to be disciplined and avoid taking more debt.
Since most debt is on reducing balance, progress made in repayment can motivate you to stick with your plan. Also, seek professional intervention from a financial expert who will review your loan terms and assist in negotiating with lenders.
To sum up
Unsecured debt has no collateral – the borrower-lender relationship depends on trust. Your promise and commitment to pay to the source solidify the agreement. Examples of liability in this category include credit card, signature loans, peer-to-peer borrowing and student loans. The credit facility is viable under short-term conditions owing to the high rates of interest that it attracts. Debt consolidation comes in handy where you have multiple loans that make it hard to keep track. By making one payment instead of several, you have better control over your finances.