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Loans are funds extended by banks or financial institutions based on the agreement that the borrower would repay the amount in full along with certain interest on a monthly basis. The monthly installment which is paid back to the bank or financial institution is termed as equated monthly installment (EMI) which includes both principal and interest.
Unsecured loans are often called as personal loans or signature loans, since they are extended without any underlying collateral. The terms and conditions pertaining to these loans including approval, sanction and disbursement of the loan are most often contingent on the borrower’s credit score. Borrowers must possess high credit score to gain approval of certain unsecured loans. In some cases, if the borrower falls short of the requisite credit score, then the lender may insist on a cosigner who will undertake the legal obligation to fulfill a debt should the borrower default on the loan.
About Unsecured Loans
The purpose of unsecured loans is generally determined by the borrower. Any loan that does not have an underlying collateral is termed as unsecured from the perspective of the bank or financial institution. If the borrower intends to utilize the loan for multiple purposes and not necessarily to acquire any asset, the borrower may choose to avail a personal loan. Such personal loan may or may not be used to acquire assets, however, do not have any asset as collateral with the bank. The basic purpose of unsecured loans is to make funds accessible to individuals who may have many financial commitments which they may not be in a position to honor due to the lack of funds.
While the most common type of unsecured loan is personal loan, there are other loans such as education loans or student loan, overdraft protection line of credit, paycheck lenders, credit cards.
The key features of unsecured loans are as mentioned below –
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.
No 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.
Lower loan amount
The quantum of loan extended in the case of secured loans is higher compared to unsecured loans. The same applicant with same credit score will be able to borrow a sizeable credit from the bank or financial institution if the loan applied for is secured. On the contrary, the borrower will be allowed to borrow only a smaller loan value under an unsecured loan.
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. While most unsecured loans have a fixed term and do not translate to a revolving debt, credit cards are examples of revolving debt within the unsecured loan category. The monthly payments, interest rates are variable and can change every month based on the outstanding balance.
Most banks or financial institutions extend unsecured loans to salaried and self-employed individuals. Unsecured loans are suitable for people who do not have any asset to pledge. The borrower has to have a good credit score to be able to negotiate a good interest rate. If the borrower has a bad credit score, the bank or financial institution may still choose to extend the loan with a higher interest rate or may insist on a co-signer who will undertake the legal obligation of paying the outstanding loan in full incase the borrower defaults. The borrower can improve the credit score by paying off existing debt, making prompt installment payments etc.,
No collateral :
This is the only type of loan which does not require any collateral. This is suitable for any individual who does not have the required equity to secure the loan. This also enables the individual to borrow for other purposes not limiting to acquisition of assets. Borrowers can use this mode of borrowing to gain fast cash, this cash could be used to pay off credit card overdue or any other loan which needs to be closed on priority.
Small loan amount for shorter term :
The unsecured loan provides loan amount that can be repaid in a shorter span of time. The purpose could determine the quantum and tenure of borrowing. The smaller loan amount enables the borrower to find some quick cash to pay off obligations and the shorter tenure enables them to rotate the fund flow from other avenues to plug the repayment of this loan. The shorter tenure also works in favor of the lender. Unsecured loans which turn to bad debts can be written off within a shorter span of time, thereby not adversely affecting the health of the Balance Sheet.
Multi-purpose loan :
The unsecured loan can be used as a multipurpose loan, it need not be used for acquisition of any asset. Typically, it may be used to clear off other high interest debt, credit card overdues etc. One can use it for any purpose, be it medical emergency, wedding, travel, to buy a new gadget, etc.
The interest rates on unsecured loans are on the higher side as compared to that of secured loans. The lowest rate at which unsecured loans are offered is 10.99% across most leading banks in India. Like all other loans, there are processing charges applicable on unsecured loans. There are many banks which provide competent interest rates and flexible repayment features. The range of the interest rate on any unsecured loan is between 10.99% to 32%. The borrowers can get the best interest rate based on their credit profile, income, employment and age.
Most of the banks have an online portal to facilitate unsecured loan application. The prospective customer can also call on the toll-free numbers to seek assistance in availing an unsecured loan. The eligibility for the loan would depend on the individuals credit score and ability to repay the loan. The documentation for unsecured loan would be like that of other loans, however, the paperwork would be more stringent and verified meticulously. The proofs required include income proof, age proof, address proof, identity proof. The standard set of proofs issued by Government of India are accepted for unsecured loan.
1. Who can apply for unsecured loan?
Unsecured loan is extended to both salaried and self-employed professionals.
2. What is the key difference between secured and unsecured loan?
Secured loans – collateral exists, nominal interest rate, higher loan value, longer and flexible tenure
Unsecured loans – no collateral, high interest rate, low loan value, shorter and fixed tenure
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