Sometimes, those among us lucky enough to have perfect or excellent credit ratings may be offered the option to take out an ‘uncollateralized’ loan.
This means that you can receive a cash loan from the bank, without having to secure the money against something real that you already own, such as your house, your vehicle, ownership of stocks and bonds, or insurance bonds.
Read on to learn everything you may need to know about uncollateralized or unsecured loans, from how to apply for them, their pros and cons, as well as their banking alternatives.
What Is An Uncollateralized Loan?
If you have a great track record with credit and loans, you may be offered an uncollaterlized loan by your bank or credit union.
This means that they can receive a loan, without having to put up any financial backing, or collateral.
Lending done without any kind of collateral (also sometimes called a personal, signature, or unsecured loan) are usually only given to account holders or bank members that have along history of customer loyalty to the bank or credit union.
Depositors that are typically given signature loans usually already have large amounts of cash already in investment accounts (including things like retirement and savings accounts), and a long record of sound money management.
This is so the bank feels confident that they will be repaid, even without the security of any kind of financial backing or collateral.
What Is Collateral?
The term collateral refers to an asset that a lander (such as a bank or credit union) will accept as security against a loan.
In general, a history of cash deposits is not enough security for a lender to be confident that their loans will be repaid, although it does show that the borrowing party does have the ability to manage their money.
This is because a borrower is able to totally empty a bank account that was previously brimming with cash in just a few minutes.
Therefore, collateral offers the bank physical or financial backing to support an application for a loan.
Lenders will typically request some kind of collateral that they can repossess if the borrower fails to make loan repayments.
Collateral usually comes in the form of real estate equity, insurance bonds, ownership of stocks or bonds, or other kinds of real property, such as a car, a boat, a motor home, other kinds of vehicles, or even gold coins.
How To Apply For An Uncollateralized Loan?
Usually, when you are applying for an uncollateralized loan, you will need to fill out an application, listing all of your checking and savings accounts, all of your sources of income, and all of your outstanding debts, if any.
Your application form will also require information about your credit cards and change cards, mortgages, auto loans and student loans, as well as a list of any other uncollaterelized loans held by the applicant.
The information you provide must be accurate and pretty detailed – including things like the exact amount due on each debt, and the change cards.
This will allow the potential lender to look at your key information, showing that you have good borrowing and repayment habits.
Lenders will require employment information, as well as details about the potential borrower’s spending habits.
After the application has been filed, the lender will look at the creditworthiness of the borrower requesting an uncollateralized loan.
This is done by the examination of credit reports and bank accounts. Lenders will also confirm your employment, monthly take-home pay, and any other resources of income (including everything from pensions to payments from court settlements).
If the bank or credit union has assessed that the risk is acceptable, and the credit report is clear, then the lender has the borrower sign an agreement for the uncollateralized loan.
The agreement will list all of the important details, such as the loan amount, the repayment schedule, and penalties if the borrower fails to meet the terms of loan agreements.
What Happens If The Borrower Defaults On The Uncollateralized Loan Agreement?
If the borrower fails to repay the loan or follow the terms that were laid out in the loan agreement (which is known as defaulting on a loan), the lender can file a lawsuit against the borrower to collect the amount that they laid out.
During the process of taking legal action, the lender can continue to charge interest on the unpaid loan balance.
When the borrower fails to make repayments for an uncollateralized loan, then the lender can report the default to a credit agency, who will begin the process of debt collection from the borrower, depending on the amount that is owed, this may include filing legal paperwork.
The lenders also have the option to sell the loan to a collection agency, which is a secondary company.
They will then take over the efforts to collect the loan from the borrower, which they hope to make a profit on.
Do Uncollateralized Loans Affect Your Credit Score?
In short, yes, uncollateralized loans impact your credit in much the same as a loan that has been secured with collateral.
When you apply for both kinds of loans, the lender will check your credit score and report, so that they can assess the risk that they are taking when lending to you.
If you have made all of your previous loan repayments on time, then you will have built credit.
Once you have a collateralized or uncollateralized loan, they will report your payment history and balance (in addition to any negative information, such as collections, defaults, foreclosures or legal judgements, if any).
This information will go to one of the consumer credit companies, such as Experian, TransUnion and Equifax.
The information will form the basis of your credit score and report for any future lenders to see when you submit a loan application.
Pros And Cons Of An Unsecured Loan
There are a number of pros and cons to any kind of loan or credit, that you should carefully consider through the lens of both your current and future financial situation.
Here is our list of pros and cons.
Pros Of An Unsecured Loan
- There is no risk to personal property if you get laid off, or if repayments become impossible.
- The application process is simpler.
- These loans can be multipurpose, and you usually have the flexibility to use the funds for various purposes, which you don’t usually have the freedom to do with a secured/collateralized loan.
- Early repayment is an option, with no/fewer onerous early exit penalties.
Cons Of An Unsecured Loan
- If you default on your loan repayments, then they might cone after you, and may be able to place a lien on your assets. It can strain your previously good credit report.
- Loan amounts might be smaller, especially if you have a slightly lower credit score, as the lender will want to minimize their own risk.
- Rates and payments are higher, as uncollateralized loans are riskier for the lender.
In conclusion, uncollateralized loans can be a useful financial resource, but you might be unlikely to get one if you do not have an excellent track records with loan repayments and a great credit report.
If you think this could be a good option for you, then shop around in a few different places to find the best loan deals on the market, and don’t rush into anything without performing your due diligence.
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