Unsecured Loan

Financial Dictionary -> Loans -> Unsecured Loan

A lot of loans have to be backed up or secured by something of value, this is called collateral. If a borrower is loaned some money and for whatever reason cannot finish off paying the loan, that collateral is then used to cover the lender's losses. A common form of collateral when taking out a mortgage on a home is the house itself, meaning if the mortgage owner defaults they may be forced in to a foreclosure process whereby they lose their property. Collateral is a reasonable way to secure the lender's money and to ensure that they get what is owed to them.

Therefore an unsecured loan is when a loan is given out with no collateral; more specifically it is based solely on the borrower's credit rating or simply the good name of the borrower (e.g. if you set up a personal loan for a family member). The borrower is still responsible for repaying the loan and there are still consequences if the terms of the loan are broken, but there is nothing tangible to back up the loan. Unsecured loans are more common if an individual needs to borrow a small amount of money (personal loan). You can also get unsecured business loans where the business is responsible for repayment; although again there is no asset in place to use as collateral.

Because there is more risk to a financial institution when giving out this type of loan they may make substantial background checks on the borrower's financial history to ensure that they are reliable. You are unlikely to get an unsecured loan if you are blacklisted and have a very bad credit score. On the flip side an unsecured loan is a lot less risky for the borrower who is not legally required to hand over collateral. Usually if a default occurs things like payment plans or other terms are negotiated.