Most loans and other financing plans fall into two main categories: secured and unsecured. Secured debts are backed by collateral, which acts as security in case the borrower defaults. It is the primary difference between secured and unsecured debts, which are loan/credit offers without collateral. This raises the counterparty risk, explaining why unsecured loans often carry higher interest rates. Here’s a brief overview of unsecured debts, including how they work, the caveats and key differences with other offers.
Unsecured vs. Secured Debts
Common types of unsecured debts include credit cards, medical loans, payday loans and some personal loans. On the other hand, secure loans include mortgages, car and yacht loans, or any debt without a form of security, such as collateral. Borrowers can put up various assets as collateral, including physical property, like a house, car, piece of land, or stocks and shares. There’s no good or bad to either loan. However, it is essential to understand the caveats that each carries.
In unsecured debts, the creditor awards the loan based on the borrower’s creditworthiness. There’s no security if the borrower cannot repay the loan, significantly raising the counterparty risk. This increased risk results in higher interest rates and shorter repayment periods. Credit cards carry interest rates around 15.07%, while personal loans can claim up to 36% in interest. Payday loans have the highest interests, up to 391%, which is their main demerit.
Secured debts have collateral as security, which means the creditor can claim the asset and use it to repay your outstanding loan. These debts also carry lower interest rates and significantly longer repayment periods. Creditors also review creditworthiness, but the minimum score is lower than what unsecured debt creditors require. If you default on your unsecured debt, the creditor may hand you over to debt collectors or sue you for the outstanding amount.
Benefits of Unsecured Loans
Unsecured loans have various merits and can provide enough to take care of your financial needs. They are much easier to qualify for and often disbursed on the same day. Payday loans, for instance, can be disbursed within 24 hours of requesting. Other advantages include:
- None of your assets is on the line
- The loan limit increases significantly every time you pay on time
- Fewer requirements other than credit checks
- You can complete the application online
- You can apply from multiple creditors
Unsecured debts aren’t all that great, especially when it comes to repayment. Interests are already high and can soar if you delay repayments, resulting in more debt. Unsecured loans also push more people into a cycle of debts that are hard to exit. You only have a few days or weeks to repay the loan, so it is essential to make sure you can raise the loan plus interest before the due date. Failure to pay on time will increase your debt and damage your credit score.
Reducing the Burden of Unsecured Debts
Unsecured loans can leave you unable to get out of debt without aggressive measures. It is advisable to avoid these loans because you pay a lot more in interest than secured loans. However, many people rely on such credits, which can come in handy when you need cash fast. Here’s what you can do to avoid falling deeper into debt:
- Pay multiple times during the month to offset your debt
- Build an emergency fund to take care of instances that make you resort to unsecured debts
- Design your bare-bone budget and stick to it. You should also ditch some expenses and habits
- Transfer your credit card balance to one with lower interest
Unsecured debts are great when you need cash urgently, but you should ensure you have the means to repay the loan before its due date. You should also compare existing options to find the ideal loan product for your needs.