Unsecured loans are loans that don’t require collateral to be approved for the loan. The lender will check your creditworthiness and consider a few other factors, such as income, savings and debt, to see if you qualify.
Because the lender is taking on more risk when the loan isn’t backed by collateral, they may charge higher interest rates and require good or excellent credit.
Features of unsecured loans
Absence of collateral
Collateral is the safety that the lender leverages against while extending funds to the borrower. In the case of unsecured loans, there is no collateral provided. In case of default by the borrower, the lender will be required to write off the unsecured loan as a bad debt.
High interest rates
Unsecured loans increase the risk for the lender significantly. As a form of compensation for the additional risk assumed, the lender often charges high interest rates and strict pre-requisites for unsecured loans. While this does not compensate the risk assumed by the bank, it does provide enough incentive for the banks or financial institution to run this line of business. The only means by which the bank can counteract if the borrower defaults is to file a case and take the matter to court.
tax benefits
Some of the loans extended by banks often qualify for tax benefits, for example home loans provide tax benefits. Unsecured loans do not provide any such tax benefit. Often, company car loans (termed as company car lease) where the funds are borrowed from the perspective of tax break is yet another example of how secured loans can provide tax breaks and lead to additional savings.
Short payment term
The payment term for unsecured loan is lower. They range from 3 months to 5 years. There are no flexible terms allowed in repayment of the loan amount.