Credit history is key to unsecured personal loans

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Ask a Lender
August 31, 2016 | Updated September 25, 2017

Key Points

Facts about unsecured personal loans

  • Are not backed by property or other collateral.
  • Typically carry higher fixed rates than term loans.
  • Typically carry lower rates than credit cards.
  • Can be a good option for consolidating credit cards.
  • Can be risky, so read the fine print.

Unsecured personal loans can be an option for raising quick cash to consolidate debt or make a large one-time purchase. These loans often can be had in a much quicker timeframe and with fewer fees and less paperwork than a traditional second mortgage, car loan or secured line of credit — such as a home equity line of credit.

Unsecured loans often carry terms of between one and five years and aren’t backed by property or savings. Lenders are agreeing to gamble that the borrower will make the payments based on a good credit history and a steady income. There is a price to be paid for that gamble, however, in the form of a higher interest rate.

Personal loan costs

Because the borrower doesn’t risk losing their house or car by defaulting on the payments, unsecured loans are usually much more expensive than a traditional loan secured by collateral. In a typical scenario, an unsecured loan will carry a rate of at least 3 percentage points above the rate of a secured loan or secured line of credit and a couple of percentage points below the typical rate for a credit card. But this is just a rule of thumb.

You can pay rates on personal loans that approach those of high-interest credit cards, so you have to evaluate closely whether the unsecured personal loan is really saving you any money. For relatively small purchases that can be paid off quickly, it may make more sense to hunt for a credit card with a special offer. 

People commonly use personal loans to consolidate credit card debt, and this can be a smart strategy. Most unsecured loans carry a fixed rate, whereas credit cards feature adjustable rates, so people can use a personal loan to roll all of their debt into one easy, predictable payment.

This strategy can also bring trouble, however. Sometimes people forget that that a personal loan isn’t a gift, but rather a debt with strict repayment terms and consequences in the event of a default. They fall into the trap of using a personal loan to wipe clean their credit card balances only to rack up new debts on those same cards — so the borrower is left with a new pile of debt that can lead to severe financial hardship.

Personal loan risks 

Another danger of an unsecured personal loan stems from it being a form of easy credit. Unsecured loans typically don’t require as much paperwork as secured loans, and the proceeds can sometimes be deposited in your checking account in a matter of days. This is one of the selling points of such a loan, but it also could tempt you to borrow more money than you need, resulting in more debts and higher monthly payments.

Personal loans also can contain special conditions, such as stiff penalties and fees for early payoffs. While most personal loans offer fixed rates, some are adjustable. Borrowers sometimes forget to read the fine print that reveals the true cost of the loan — and fall into the trap of grabbing the cash and not shopping around for the best deal.

An unsecured personal loan has its place as a tool for empowering consumers, but borrowers shouldn’t rush out and get one without careful consideration of the their existing finances and the potential consequences of becoming overextended on the debt front.

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