The most visible type of unsecured credit is openly at work every time a consumer takes out a standard credit card to pay for goods or services, whether at a local store or on an ecommerce website. But unsecured credit goes beyond credit cards and encompasses other types of commercial and personal loan programs.
The label “unsecured credit” refers to any financing product that does not require additional collateral or pledged assets as security for the loan. By contrast, secured credit requires the borrower to pledge or provide an acceptable asset as security for the loan.
Unsecured credit vs. secured credit
From the lender’s point of view, one of the biggest differences between secured and unsecured credit is the level of loan risk exposure.
When a secured credit program requires the borrower to pledge or give some sort of collateral for a secured loan or credit line, the borrower is sharing some of the risk. If the borrower defaults on the secured credit, the borrower is also jeopardizing the collateral that he or she put up. Secured credit lenders and creditors can use the pledged collateral to pay off any balance or charges owed on the defaulted secured credit debt.
An unsecured credit product, however, shifts more of the risk to the lender. By not requiring any collateral or security for the loan or credit line being extended, the lender on an unsecured credit product takes on more risk while the borrower takes on less risk.
Today’s secured credit products include the following:
Car loans. A common type of secured loan is an automobile loan. Most automobile lenders will issue a loan and hold the title to the car being financed. If the borrower fails to make payments as agreed, the lender can use the title to repossess the vehicle from the borrower.
Mortgage loans. The biggest debt many Americans will ever carry is the financing they use to buy or refinance their home. A mortgage loan is secured by the title to the home or other real property, which is “mortgaged” to obtain the loan funds.
Secured credit cards. Many consumers unable to qualify for standard credit cards often turn to secured credit cards, which require the borrower to make a security deposit with the bank issuing the credit card. That security deposit becomes the collateral for the secured credit card. If the borrower defaults on the secured credit account, the creditor will use the security deposit to pay off the balance due. The security deposit may earn interest income for the borrower, but it usually cannot be used to make regular payments.
Home equity line of credit. Sometimes called a HELOC, this mortgage loan product combines a home equity loan with a credit line. Like a home equity loan, the HELOC is secured by a lien on the home or real estate owned by the borrower. However, instead of a lump sum loan check, the HELOC provides the borrower with a checkbook, allowing the borrower to draw against the HELOC limit.
Types of unsecured credit
In addition to the standard unsecured credit card example mentioned above, other forms of unsecured credit include the following financing programs:
Personal loans. Also called signature loans, an unsecured personal loan is provided to an individual, either by another person or a lending institution. Many banks, credit unions and finance companies offer personal loans to their retail customers.
Personal lines of credit. Unlike a personal loan, the personal credit line is usually more open ended. The borrower doesn’t receive a lump sum for the loan. Instead, he or she receives a credit line and can draw funds against it multiple times, up to the credit limit. The monthly payments are usually calculated based on the current loan balance in the credit line.
Student loans. One of the most prevalent (and largest) types of unsecured credit for most young adults is the student loan. Although student loans require no collateral, defaulting on a federally guaranteed loan can have serious implications, such as affecting other loan applications and allowing the government or creditors to garnish wages and pursue repayment for decades.
Cash advance loans. Also called payday loans, a cash advance loan is a very short-term loan that requires no collateral but is usually paid off with the borrower’s next pay check.
Peer-to-peer loans. Also called social, person-to-person or P2P lending, a peer-to-peer loan is a type of personal loan in which the borrowers and lenders are typically individuals (not lending companies).
Where to get unsecured credit financing
Consumers shopping for unsecured credit have various avenues and options available. The following sources all provide different types of unsecured credit products:
- Retail and commercial banks
- Credit unions
- Loan brokers
- Financing companies
- Peer-to-peer loan facilitators
- Credit card providers
In addition, many unsecured credit providers now have websites that allow consumers to complete online loan applications – and even get approved online.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.
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