Why are higher interest rates charged for an unsecured loan?
By: Hitesh Khan/
You need money and fast. Without a great credit score or any type of collateral to your name, the only option is an unsecured loan. After searching the web, you have noticed the interest rates are substantially higher for an unsecured loan than other types of loans out there. The fact doesn’t change that you still need to borrow the money, but now you cannot help wondering, “Why are higher interest rates charged on personal loans.”
Most personal loans are granted as unsecured loans. Borrowers don’t necessarily need to have the best credit or even any type of collateral as that is not the primary concern for the providers of these types of loans. An unsecured loan is provided more on good faith and what lenders need to provide are their name, NRIC and income verification.
No collateral is needed so if the loan goes into default, the lender will not get anything in return. Higher interest rates charged are the price to pay for not having collateral or a co-signer on this type of unsecured loan.
Because the lender is not operating with any type of collateral from the borrower, they are taking a greater risk. With that great risk comes higher interest rates as that is what a borrower can offer to a lender in that higher risk situation; a bigger rate of return.
Banks or other financial institutions do not usually process unsecured personal loans, thus the rules for loaning the money are not as closely monitored by the Government (although new rules regarding interest rate caps sometimes loom on the horizon).
The higher interest rates charged for unsecured loan are justification for that reason as well.
With bigger risks come bigger payouts. Whether it is in the guise of starting your own company, putting all the money on one horse to win or by lending high-risk borrowers money, the returns are greater because of the bigger chance taken. Unsecured personal loans are a great way to borrow money quickly if you are in a pinch, but it is less than likely a great bargain will be found on the higher interest rates charged that you will have to pay.
Borrow only what you need and are able to repay. Be mindful that if you are unable to meet the contractual terms, the late payment fees and interest payment will be a financial strain not just on yourself but also on your family. Regardless of how much of a financial crunch you are in, you should always shop around for the most favourable terms. You should not rush into and commit yourself to a loan until you are satisfied with the terms and conditions.
If used responsibly, credit cards too can be a great source for an unsecured loan, but can cause undue hardship to those who are not aware of the costs. They are not considered to be sources of longer-term financing. However, they can be a great loan qualification tool and source for those who need money quickly and intend to repay the borrowed amount in short order.
If an individual needs to borrow a small amount of money for a short period, a credit card (or a cash advance on a credit card) may not be a bad idea, and may be a great loan source. After all, there are no application fees (assuming you already have a card). But use that card improperly and future loan qualification will be that much more difficult.
Credit cards can be both a boon and a great loan qualification tool, as well as a curse if you are not careful with credit card interest rates. If you’re strapped for cash and really want to make that purchase, you can charge it and pay it off later. And if you have a rewards card, it may be even better because you can collect points or cash back. But, if you’re prone to carrying a balance, you’ll have to wait longer to pay it off because of the hefty interest that some companies charge.
High credit card interest rates means carrying a balance on your card can be very costly. Pay off your credit card balance entirely. With the astronomical credit card interest rates companies charge, it simply does not make sense, if you have savings elsewhere, to carry a balance. If you can’t completely pay off your balance, at least increase your monthly payment, even a little bit. It will be more profitable in the long run.
If you get a credit card, you should plan to pay the full amount owed every month. That way you avoid the exorbitant credit card interest rates charge, and you also benefit from the grace period (which in effect enables you to borrow money for a few weeks for free).
Getting an unsecured loan can be easy even for borrowers with imperfect credit. However, getting an unsecured loan will never be easy for unprepared borrowers with imperfect credit. To maximise chances of keeping the approval process smooth and simple, take steps to make it easy for a lender to approve this loan, no matter the credit issues and no matter the lack of collateral.
A personal loan, since it is designed to be a short-term, smallish loan, relies very heavily on a borrower’s income, so apply for an unsecured loan when you get the first hint that you are going to be unemployed – not when you are already in the unemployment period. Establishing current and verifiable employment, as well as employment history, is priority number one for the personal loan applicant who wants to make approval a slam dunk.