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Unsecured Personal Loans

How They Work, Various Types

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Unsecured personal loans allow you to borrow money for almost any purpose. You can use the funds to start a business, consolidate debt, or buy an expensive toy. Before you get an unsecured loan, make sure you understand how they work and what the alternatives are.

Basics of Unsecured Personal Loans

When a loan is unsecured, there is no property or collateral to “secure” or guarantee the loan. For example, a mortgage loan is secured with property -- if you don’t repay the loan, your lender has the right to sell your home and collect what you owe out of the sales proceeds. With unsecured loans, nothing specific has been pledged as collateral. This makes them a little less risky for you (the borrower) because the consequences are not as immediate if you fail to repay.

Lenders, on the other hand, take more risk with unsecured personal loans. They don’t have any property to sell if things go badly, but of course they have other options available if they want to pursue repayment (they can take legal action against you and attempt to collect from your wages, for example). Because lenders take more risk, they generally charge higher interest rates for unsecured personal loans than they do for secured loans.

Your credit is one of the most important factors that determine whether or not you’ll get an unsecured loan. If you have good credit, you’ll pay lower interest rates and you’ll have more options available to you. If you have bad credit, you can’t be as choosy, and you may need a co-signer to get approved for a loan.

Types of Unsecured Loans

There are several types of unsecured personal loans available, and each type comes with tradeoffs. Try to pick the one that best meets your needs while minimizing cost.

Signature loans are the most basic type of unsecured loan. As the name suggests, they are secured by nothing but your signature -- your promise to pay. These loans are available at banks and credit unions, and you can use the money for whatever you want. They are generally installment loans that amortize over time, so you borrow once and pay a fixed monthly payment until the loan is paid off. These loans are a good choice if you’ve got good credit because they generally come with a relatively low interest rate. Signature loans can also help you build credit so that borrowing is easier and less expensive in the future.

To get a signature loan, tell your bank that you’d like to borrow money using an unsecured loan.

Credit cards are another common way to borrow. When you use a credit card, you have a pool of money available that you can borrow. You don’t get a lump sum, as you do with a signature loan. Instead, you borrow whatever you need whenever you need it. If you need more money at a later time, you can charge more to the credit card (up to your credit limit). Credit cards are popular because they make borrowing easy: once you’re approved, you can borrow practically instantly. Unfortunately, the interest rate you pay on credit cards is generally quite high. Yes, you can get a “teaser rate” and borrow at 0% for a while, but those rates always end. It’s easy to get in trouble with credit cards -- you can quickly end up paying hundreds of dollars per month in interest costs.

To get a credit card loan, check your mail (your mailbox may be full of offers) or search for good deals online.

Student loans are unsecured loans designed for education funding. If you’re a student, they’re often a good first choice because student loans have features that you can’t find elsewhere: flexible repayment options, grace periods, interest subsidies, and more. With some loans, it doesn’t even matter if you have good credit. The only hitch with student loans is that you have to be a student.

To get a student loan, visit the Financial Aid office at your school. They will guide you through the process (there’s a lot of paperwork involved) and help you decide what to do.

Peer to peer loans allow you to borrow from individuals, as opposed to borrowing from a traditional lender such as a bank. Several websites allow you to post a loan request online, and people may or may not step in and fund your loan. These loans, like signature loans, are generally fixed rate installment loans, and they have competitive interest rates. They also allow you to borrow a modest size lump sum if you need a lot of money. However, your credit still matters in most cases.

To get a peer to peer loan, visit one of the popular P2P lending sites. Prosper.com (review) and Lending Club (review) are good places to start.

If you have bad Credit

It’s not impossible to get an unsecured loan when you have bad credit, but it’s difficult. You have fewer choices and you’ll have to pay more than a borrower with good credit. If you’re having a hard time borrowing, learn about getting an unsecured loan with bad credit. If it's feasible, hold off on borrowing until you've built your credit up to the point where you can get loans on attractive terms.

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