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Common Loan Types: Basics on Unsecured Loans

In part one of this two-part blog series, we went over some basics on secured loans and what they mean. Present across a number of loan types, secured loans refer to those that are backed by collateral, meaning the lender can claim this collateral if the borrower is unable to pay the loan back in the agreed-upon terms and timeline.

At Diversified Members Credit Union, we’re proud to offer a wide range of loan products to our clients, from mortgage loans and home equity loans to auto loans and many others. In today’s part two of our series, we’ll look at the other side of this coin: Unsecured loans. What are they, why are they sometimes used, and what risks do they carry? Here’s a primer.

loan types unsecured loans

Unsecured Loan Basics

Unsecured loans, as you may have already guessed, refer to those that are not backed by collateral. Because of this, unsecured loans are sometimes also called signature loans or personal loans. The approval process for an unsecured loan is generally based on the borrower’s creditworthiness rather than the value of any property that could be used to secure the loan.

For this reason, those looking for an unsecured loan generally must have reasonable credit scores, debt-to-income ratios and/or income to qualify. Unsecured loans can be used for a variety of purposes, from consolidating debt to financing a large purchase.

Interest Rates and Repayment

Generally, because the risk to lenders on unsecured loans is higher than with secured loans, unsecured loan interest rates will be higher as well. The repayment terms on unsecured loans also tend to be shorter than with secured loans; borrowers typically have between two and five years to repay an unsecured loan, while a mortgage loan, for example, may have a repayment term of 15 or 30 years.

Why Unsecured Loans Are Used

There are a few reasons why borrowers might choose an unsecured loan over a secured one. In some cases, the borrower may not have any collateral to offer or may not want to put up any property as collateral. Additionally, some people simply prefer unsecured loans because they don’t want to risk losing their property if they can’t repay the loan.

Risks of Unsecured Loans

Now, unsecured loans do have some risks that borrowers should be aware of. First, as we alluded to earlier, the interest rates on these loans are generally higher than with secured loans, which can make them more expensive in the long run. Additionally, because unsecured loans are not backed by collateral, lenders may be less willing to work with borrowers who have difficulty making payments, meaning it could be harder to get help if you run into financial trouble.

Now, the risks if you fail to repay an unsecured loan are different from a secured loan. While you won’t be at-risk of losing your home or car, for example, failing to repay an unsecured loan could still damage your credit score and make it difficult to get approved for loans in the future. Additionally, you may be subject to late fees, collection calls and other penalties if you miss loan payments.

For more on secured versus unsecured loans, or to learn about any of our loan products or other services, speak with the team at Diversified Members Credit Union today.

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