What Is an Unsecured Loan?
Loans help you obtain capital for your business. Of course, you are always expected to repay your loans with interest via a monthly installment plan. The type of loan you receive is determined by the degree to which lenders trust your ability to pay them back. Depending on your financial situation, you can expect either a secured or unsecured loan upon lender approval.
An unsecured loan is a sum of money that is borrowed without the use of collateral as insurance. Collateral refers to valuable assets that are put at risk when the borrower accepts the loan agreement. Since there is nothing tangible on the line with an unsecured loan, lenders instead look at your creditworthiness to determine if you are likely to pay them each month.
What Is a Secured Loan?
Secured loans involve a sum of money borrowed against valuable assets put up as collateral. The reason a borrower would be willing to risk personal property is largely due to the less demanding terms presented in secured loan agreements. Typically, the borrower can secure a lower interest rate because lenders believe that clients are highly motivated to pay them back on time.
The Different Types of Collateral
Collateral can be anything that represents an equal value to borrowed money. Basic examples include real estate, jewelry, vehicles, antiques, and any miscellaneous items that fetch a high price. Keep in mind that sentimental value is rarely considered when tallying this dollar amount.
How Do Unsecured Loans Work?
Unsecured loans rely on the credit score of the individual or business applying for the money. Since you are not putting anything tangible on the line, creditors look at your historical ability to pay back others. The higher your credit score, the more likely you are to get a loan with a reasonable interest rate.
Considering the higher standards for this loan type, a co-signer can sometimes be used to secure a loan that would be otherwise out of your reach. Co-signers leverage their high score to obtain the loan on your behalf, but their credit will be negatively impacted should you ever miss a payment. Also, they agree to take on the legal responsibility of the debt should you default completely on the loan.
When solo borrowers default on a loan, their credit score will tank into the low range. The lender may then choose to take them to court. When lenders win such cases, borrowers can have their wages garnished to gradually repay the debt. If no legal action is taken, both parties go their separate ways and accept their losses.
What Is a Credit Score?
Your credit score is a quick snapshot of your history in paying back lenders and other financial institutions. Keep in mind that your business has a credit score that is separate from your personal record. There are several credit bureaus, each with its own scoring algorithm. As you acquire loans and credit cards and make large purchases that require monthly payments, your ability to pay everyone back on time is tracked by each bureau.
When it comes time to secure a loan or get another credit card, the lender will check in with one or more bureaus to see how likely you are to repay your debt based on your past experience. The credit score gives an expedient overview of the full credit report created by each bureau. It is important to check your credit history regularly to ensure there are no errors.
As your credit score climbs, your overall credit rating will adjust accordingly. Each rating is used by lenders to determine which interest rates and repayment periods to offer. A great credit score gives you access to the best deals on business loans, car purchases, and mortgages. You can even gain access to additional credit cards with more lucrative rewards and benefit structures.
The Two Main Types of Unsecured Loans
Unsecured loans can be used to attend college, get credit cards, or start businesses. Depending on what the money is for, you can expect to receive either a revolving or term loan when signing your agreement. A revolving loan is an ongoing account with a specified credit limit. You can spend as much as you like within that limit and the threshold resets each time you pay back the money. The most straightforward example of this is a credit card that you pay down each month.
A term loan is a fixed sum of money that must be paid back within a certain timeframe. The debt is considered paid at the end of the period, provided each payment was made on time. Term loans are most often measured in months, and each payment is scheduled for the same day each term. Since each payment only accounts for a small fraction of the principal at the beginning of the loan period, paying more than the monthly minimum is an effective way to drastically reduce the overall time spent in debt.
Sometimes, a revolving loan can be converted to a term loan through a consolidation strategy. Consolidating allows you to merge multiple lines of credit into a single loan from one lender. This simplifies and ideally reduces your monthly payment while making it easier to keep track of due dates.
Comparing Unsecured Loans With Payday Loans
While unsecured loans have gained a reputation for higher interest rates compared to secured loans, the business model remains fair and reasonable for everyone. However, there are some instances in which a borrower does not have the credit score to obtain a traditional loan. In these cases, you may be tempted to apply for a payday loan due to the lower credit requirements.
These loans are technically unsecured, but borrowers often sign an agreement that allows the lender to automatically withdraw money from their checking account to make payments. This results in a hybrid loan that is partially secured by access to your banking institution. These loans typically have unusually steep interest rates, including some as high as 400%. When possible, opting for a traditional unsecured loan is beneficial to the borrower.
More Unsecured Loan Considerations
A credit score is the main factor that determines whether you leave the bank with a loan. However, there have been several provisions throughout the years to make the process as smooth as possible. Numerous laws have been introduced to protect borrowers from discrimination of any kind. Most notably the, Equal Credit Opportunity Act of 1974 introduced guidelines that allow everyone an equal chance at funding capital.
Will Declaring Bankruptcy Eliminate Unsecured Loans?
Bankruptcy is a drastic option for people in financial distress. While the technique will crash your credit score, your traditional unsecured loans will also be dismissed in the process. In some rare cases, this might be worth it to someone in immense debt. However, there is a type of unsecured loan that does not always get washed away during bankruptcy. Student loans are backed by the federal government and thus, play by their own rules. The borrower will still have to pay this specific loan in full.
How to Acquire an Unsecured Loan
Your success rate when applying for unsecured loans is based on your overall creditworthiness. This means preparation is key before you fill out an application. Here are a couple of best practices to greatly improve your chances of obtaining your loan.
Check and Bolster Your Credit Score
Knowing your credit score is half the battle when obtaining loans. Having an idea of what you can get with your score helps immensely as well. To get the best interest rates, you will likely need a credit score in the mid-700s. Keep in mind that each bureau will give you a slightly different score. If your score is not there yet, check the thresholds for each credit rating. You may be able to improve your rating by only raising your score a few points. Obtaining a higher rating right before applying will place you into a better interest rate bracket and increase your options tremendously.
Determine How Much You Can Safely Pay Back Each Month
Closely monitor your budget and expenses to figure out how much you can reliably pay back every month for the foreseeable future. Once you have a safe dollar amount in mind, you can compare your ideal number with any loan offers you receive. If you can comfortably afford the monthly payment, you will not have to worry about defaulting down the line.
Prepare Documents and Business Information
When applying for loans, lenders may request various documents, such as tax returns and income statements. Gathering these before applying will save you time and often results in the application being processed more quickly. Appearing organized will also instill confidence in your lender that you are a responsible party worth funding.
Apply for the Loan
With all your data in tow, it is time to acquire some capital. You can apply for unsecured loans online via our web application or by calling our friendly support staff.
Get Your Small Business Loan Today
At American Business Credit, we make acquiring capital for your business as easy as heading to our website and starting the application process. From there, we will help you obtain unsecured business loans for whatever your dream project entails. Whether you need startup funding, franchising, agricultural, restaurants, industrial equipment, or anything else, we have a way to get you up and running.
We happily work with veterans, minority-owned businesses, and anyone looking to take that next big step in their life. If you are serious about building a bright future filled with success, then head over to our website to fill out a loan application today.