There are two different types of loans available in the market, and those are secured loans and unsecured loans. Personal loans are typically part of the later, although there are some lenders out in the market that offers secured personal loans, the vast majority of financial institutions and lender an applicant will interact with will be offering them an unsecured personal loan.
Difference between Secured and Unsecured loans
Before we took a deep dive into the topic of personal loans, one needs to first get a better understanding of what is the difference between a secured loan and an unsecured loan.
A secured loan can be easily defined as the loan taken by a borrower against collateral. One of the most common examples of a secured loan is a mortgage loan or car loan. Take the car loan, for example; the loan taken by the individual is for a specific purchase – to purchase a car. For this, the financial institution would lend the individual the sum of money required for them to buy the car, and in return for that, the borrower has to pay monthly EMI to the lender. The monthly EMI is a portion of the principal amount that the borrower is paying back to the lending institution and the interest levied upon it by the financial institution.
And what is the collateral in the case of a car loan – the car purchased, obviously! If for any reason, you are not able to pay the borrowed amount with the added interest back to the lender on time, the lender would be well within their rights to seize your car to settle the debt you owe them.
An unsecured loan is a loan offered by lenders and financial institutions that are not backed with any collateral. An unsecured loan is essentially given based on the applicant’s credit history as well their capability to pay out the loan amount back in full with the added interest on the loaned amount. Unsecured loans are become preferable for individuals day by day because of the added risk that is there is a secured loan. One should keep in mind that the interest rates on unsecured loans are typically higher than those of secured ones.
With an unsecured loan, one does not have to worry about getting their car seized if they miss even a single EMI, although your credit score would take a massive hit if you were unable to pay back the loan amount in full in the scheduled time, which would make it almost impossible for you to apply for a loan from any other reputable financial institution.
There are several factors taken into account before an unsecured loan is approved for the applicant.
A good credit history
If the applicant has an excellent credit history, then it is highly likely that their unsecured loan application, for example, an application for a personal loan, would get approve without much of a hassle.
A stable income
If the applicant has had a stable source of income for the past two years, then there is a high likelihood of them getting their loan application cleared without any issue.
Excellent credit score
Several agencies calculate your credit score based on your credit history, repayment of past loans, and the amount previously borrowed by you. If your credit score is in an excellent range, you will get your unsecured loan approved within a few minutes.
Why are personal loans not backed by collateral?
The answer to this is pretty simple – because they are unsecured loans. If one gives careful consideration to this as they have already given a thorough read on the points mentioned above, they will find that the personal loan is indeed secured against something, and that is the applicant’s credit score. If the borrower does not pay the loaned amount with the added interest to the lender in a timely manner, they will see a catastrophic impact on their credit score, which would hamper their ability to borrow any amount from any other reputable financial institution.
So, a personal loan might not be secured against collateral, but it would not be correct to say they are not backed in any manner.
How can one get a better personal loan rate?
While more often than you would encounter personal loan interest rates that are significantly higher than a collateral-backed loan, there are some ways you can get the interest rate down.
- By maintaining an above-average credit score
- The higher your credit score is, the lesser the interest rate on your personal loan would be.
- Have an existing relationship with the lender
- If you already have an existing relationship with the lending institution, there is a high likelihood of you getting a better offer on your personal loan.
Search the web
Several financial institutions in the market would offer you a better interest rate depending on your credit score; you just have to search for them on the web.