Whether you’re looking for a way to afford an upcoming holiday or pay down your debt, personal loans are a common choice. However, like all loans, you want to make sure you know exactly what you’re signing up for when you agree to a personal loan. Because this is something you’ll need to pay back, it’s a big financial commitment.
In addition, there are two main types of personal loans: secured and unsecured. A secured personal loan is any loan with collateral, such as a mortgage or car payment. On the other hand, an unsecured loan doesn’t have any collateral. Because of this, it’s especially important to know how unsecured personal loans work and what to expect.
In this guide, we’ll share 5 things you have to know about unsecured personal loans. Though it’s true a personal loan is a great way to finance a lot of different things, it’s always important to be careful before agreeing to a financial commitment.
What Is an Unsecured Personal Loan?
First, let’s further define what an unsecured personal loan is and how it works. Though most people have a general idea of how loans work, there can be some aspects that aren’t as clear. It’s also easy to get confused between secured and unsecured personal loans.
A personal loan is any money borrowed from a bank, credit union, or even an online lender. This money is paid back through fixed monthly payments or installments, and the term can be anywhere from several months to years.
To clarify, an unsecured personal loan is a personal loan that doesn’t require any collateral. Lenders base these loans on the borrower’s creditworthiness, income, and existing debt. It can often be harder to qualify for unsecured loans because of this, so make sure you’re getting a fair deal. Unsecured loans are used for all different things, such as:
- Debt consolidation
- Alternative to the payday loan cycle
- Holiday
- Home remodel
- Emergency expenses (medical, funeral, etc.)
- Wedding
- University
Personal loans can be a smart alternative to draining your savings account, but there are still things you need to know. Keep reading to explore the 5 things you must know before you sign for a new personal loan, regardless of your goals.
1. Personal Loans Don’t Require Collateral
To begin, it’s important to fully understand what it means when it’s said that unsecured personal loans don’t require collateral. Because it’s unsecured, you don’t need to place an asset as collateral when you accept a personal loan. However, that means these can be more difficult to get. It also means lenders can take different actions if you’re unable to keep up with payments.
It’s easy to think unsecured loans are safer since your belongings or home aren’t officially on the line, but this isn’t true. In reality, personal loan lenders can take many actions. For example, they could take your car or other assets. They can also report any late payments to the credit bureaus, hurting your credit score and sending the debt to collections.
As you can see, these loans are serious financial commitments. Though you don’t have any specific collateral at risk, you should make sure this loan fits within your budget. Using a repayment calculator is a great way to make sure it’s affordable.
2. The Interest Can Be Fixed or Variable
Next, before you sign for a personal loan, take a close look at the interest rate. In most cases, the interest rate for personal loans is fixed. However, some can be variable, and this means the amount you owe might change over time.
What’s the difference between fixed and variable interest rates? To sum it up simply:
- Fixed: As the name implies, a fixed interest rate stays the same over the life of your loan. This means you pay the same amount every month.
- Variable: A variable rate changes periodically based on the market and several other factors. That means your interest rate can fluctuate over time, and this makes it harder to budget for your payments long-term.
Ultimately, your interest rate is based on your credit score and income. If you have a better credit score, you’ll secure a better interest rate. Luckily, there are still personal loans for those with low credit scores, so don’t be discouraged.
3. You Borrow a Fixed Amount
When you take on a personal loan, there is a fixed loan amount. That means you borrow a specific amount from the lender. The amount you can borrow depends on your credit score and income. The higher your credit rating and income, the more you’ll be able to borrow.
Most personal loans vary in amount from $1,000 to $50,000. Some lenders have their own limits on how much they’ll lend regardless of income, so it’s a good idea to keep this in mind. Most importantly, never borrow more than you can afford to spend.
4. There Is a Specific Repayment Period
When you agree to an unsecured personal loan, you also agree to a specific repayment period. This is typically upwards of a year, and it’s by a set number of months. It’s usually 12, 24, 36, 48, or 60 months, though some might be even longer. The longer the period, the lower your monthly payment. However, you’ll also pay more in interest over the life of your loan.
Also, if you have open lines of credit and loans, it’s harder to get approved for new loans or credit cards. If you have a longer repayment period, you’ll want to make sure you aren’t planning any big expenses in the near future. A good rule of thumb is to choose the shortest repayment period you can afford by calculating the monthly payment.
What happens if you’re unable to pay off the loan during the repayment period? If you miss a payment, there are a lot of steps you can take. Most lenders offer forbearance or different repayment structures, but you’ll need to review your options with the lender specifically. If you fail to take any action, you could face late fees or more severe consequences.
5. Always Avoid Scams
Lastly, you need to recognize that there are a lot of scams related to unsecured personal loans. Unfortunately, many people are trying to profit off those who are in need of quick cash. If you’re unfamiliar with how personal loans work, it’s surprisingly easy to fall for one of these schemes.
How do you determine if a loan is legitimate? Take the time to familiarise yourself with the most common scams and signs of fraud. Here are some signs that you might be facing a scam:
- No credit or history check: If a lender doesn’t look into your credit report or your repayment history, this is a red flag. Lenders check these things to make sure you can make your payments on time. However, if a lender ignores them, they aren’t looking for steady repayments. They want high-risk borrowers who can be charged higher fees.
- Prepaid credit card: No reputable lender will ever ask you to send a prepaid credit card. This is a common scam, and countless people fall for it every year.
- Physical address: Nowadays, it’s common to use online lenders, and many of these are very trustworthy. However, some scammers use the internet to find targets. If the lender has no physical address, this is a red flag.
- Fees: All reputable lenders are transparent about fees and costs. If you can’t find any clear fee structure, you should walk away from this lender.
- Guaranteed approval: Finally, if the lender guarantees approval, this is a sign that you should think twice. Though it’s entirely possible to get a personal loan no matter your credit history, this type of phrasing is too good to be true.
There are a lot of different types of personal loan scams out there. It’s important to be a savvy financial shopper when considering your lending options. When in doubt, recruit an expert for help.
Is a Personal Loan Right for You?
An unsecured personal loan can be a great option for some. If you’re struggling to juggle multiple types of loan repayments or you’re looking to afford a big purchase, a personal loan might be the right choice for you. However, like with any type of financial decision, make sure you know exactly what you’re agreeing to before you sign for a new loan.
Not only should you understand the rate, term, and repayment process, but you should make sure you’re not falling for one of the common loan scams. As long as you’re not agreeing to more than you can reasonably afford, a personal loan can be a smart financial decision within a larger debt repayment strategy.
Are you considering an unsecured personal loan? It’s a good idea to talk to our experts. The team at Debt Busters has over 15 years of experience working with Aussies of all backgrounds. Whether you’re hoping to pay down debt or afford a large purchase, we’re here to help. Contact a member of our team today on 1300 368 322 for a personalised consultation.