Unsecured Loan

What is 'Unsecured Loan'

An unsecured loan is a loan that is issued and supported only by the borrower's creditworthiness, rather than by any type of collateral. Because unsecured loans, sometimes referred to as signature loans or personal loans, are obtained without the use of property as collateral, the terms of such loans, including approval and receipt, are most often contingent on the borrower's credit score. Borrowers must generally have high credit ratings to be approved for certain unsecured loans.

BREAKING DOWN 'Unsecured Loan'

An unsecured loan stands in direct contrast to a secured loan, in which a borrower pledges some type of asset as collateral for the loan, in turn increasing the lender's "security" for providing the loan. Unsecured loans are bigger risks for lenders, and as a result, they typically have higher interest rates and require higher credit scores than secured loans such as mortgages or car loans. In some instances, lenders will allow loan applicants with insufficient credit to provide a cosigner, who can take on the legal obligation to fulfill a debt should the borrower default.

What Are Examples of Unsecured Loans?

Unsecured loans include credit cards, student loans and personal loans, all of which can be revolving or term loans. A revolving loan is a loan that has a credit limit that can be spent, repaid and spent again. Examples of revolving unsecured loans include credit cards and personal lines of credit.

Term loans, in contrast, are loans that the borrower repays in equal installments until the loan is paid off at the end of its term. While these types of loans are often affiliated with secured loans such as mortgages and car loans, there are also unsecured term loans. A consolidation loan to pay off credit cards or a signature loan from a bank would be considered unsecured term loans.

There's ample data to suggest that the modernizing unsecured loan market is growing. In a November 2017 consumer credit report, TransUnion estimated that credit card balances in the United States had risen 7% in the third quarter of 2017 to $731 billion while personal loan balances reached an all-time of $112 billion. The past decade has seen the rise of peer-to-peer lending via online and mobile lenders coinciding with a sharp increase in unsecured loans. In another report, TransUnion found that "fintechs," or financial technology firms, accounted for 32% of personal loan balances through the first half of 2017, up from just 4% in 2012.

Alternative Lenders and Unsecured Loans

Alternative lenders, such as payday lenders or companies who offer merchant cash advances, do not offer secured loans in the traditional sense of the phrase. Their loans are not secured by tangible collateral as mortgages and car loans are. However, these lenders take other measures to secure repayment.

In particular, payday lenders have borrowers give them a postdated check or agree to an automatic withdrawal from their checking accounts to repay the loan. Many online merchant cash advance lenders require the borrower to pay a certain percentage of online sales through a payment processing service such as PayPal. As a result, these loans are considered unsecured; although they are partially secured.

Defaulting on an Unsecured Loan

If a borrower defaults on a secured loan, the lender can repossess the collateral to recoup his losses. In contrast, if a borrower defaults on an unsecured loan, the lender cannot claim property. However, the lender can take other actions, such as commissioning a collection agency to collect the debt or taking the borrower to court. If the court rules in the lender's favor, the borrower's wages may be garnished, a lien may be placed on the borrower's home, or the borrower may be otherwise ordered to pay the debt.