What are the Risks of Unsecured Loans?
Why do more people opt for unsecured loans? It’s quite clear that people don’t want to take risks when it comes to borrowing money from banks and lenders. When we talk about unsecured loans, these are the loans that are not backed by collateral, meaning, they do not put your home or vehicle at the risk of foreclosure.
Borrowers are more relaxed with unsecured loans because they know they will not end up losing their assets. Unsecured loans might be less risky for you, but you need to figure out how much it costs at the end of the loan period and whether it is risky or not.
In this article, you will know the many risks associated with unsecured loans. Let’s begin!
· High Fees
When it comes to an unsecured loan, your lender will ask you to pay a big fee upfront so they feel secure in lending you the money. An unsecured loan is not secured by collateral, which means the lender needs full guarantee that you will be able to repay the loan in time. They need to be certain that they will not lose their money.
· Higher Interest Rate
An unsecured loan is risky for lenders. Therefore, these types of loans have higher interest rates that end up making the loan costlier. If you are not ready to pay a higher cost for the loan, this is not the type of loan you should choose. Of course, your home will not be used as collateral, but you will be paying a lot money each month in the form of interest.
So, before you opt for an unsecured loan, make sure you understand how interest works. You can get lower interest rate if you have an exceptional credit score. Your credit score is a representation of how punctual and responsible you are in making payments.
A bad credit score shows that you are not punctual in paying your monthly fees. Therefore, if you have a good credit score, you can negotiate lower interest on your unsecured loan. When you are borrowing an unsecured loan, make sure you look at the total amount you will be paying at the end of the loan period instead of the annual percentage rate (APR).
· The Insurance Trap
There’s so much that comes with unsecured loans including additional sales pitch. Lenders might get you to buy additional things with your loan including insurance. The insurance is sold to borrowers to protect the loan and the borrower from any disability or accident.
Although it might be useful to consider insurance, you do not necessarily need to buy it from your lender. Lenders usually charge higher on insurance. It is best to feel confident that you will repay the loan in time than questioning yourself over a sales pitch. Therefore, when you go to a lender for an unsecured loan, stay prepared to hear lots of sales pitches.
· Early-Payoff Fines
Some unsecured loans don’t allow you to pay them off early. The reason for it is that the lenders have a certain amount of money they earn in the form of interest. Paying off the loan early means taking away that opportunity, which is the reason it is penalised by lenders. Therefore, it is best to make sure that your lender doesn’t put a fine on you if you pay off the loan early. In case you want to pay it off early from the beginning, talk to your lender before you sign the loan agreement so you can avoid trouble.
· Additional Offers
You go to a bank or a lender and ask for an unsecured loan. The lender shares with you their requirements and you decide whether you want to opt for the loan or not. It’s as simple as that. However, some lenders might try to sell you additional things like cashback offers, insurance, etc., to earn more. If this happens, do not get into the trap. Buying extra things means letting the lender make a fool out of you. Just get the loan and leave. That’s all.
· Interest Type
One of the things that can make it troubling for borrowers is the type of interest they have on their loans. If you have taken out an unsecured loan, you need to make sure that your interest in not precomputed. A precomputed interest is one which calculates interest based on your original payment schedule regardless of the status of your loan. This might take your interest higher, ending up in an increased loan amount at the end of the term. So, know what type of interest you are paying on your unsecured loan and make sure it is simple interest.
No matter what type of loan you are borrowing, it is important to understand its risks. Unsecured loans might make you feel relieved that your asset will not be at stake, but they have their fair share of risks that need to be calculated before time.
Questions to Ask before getting an Unsecured Loan
Loans are a great option when you need money. When it comes to unsecured loans, even with high interest rates, they are quite helpful. However, taking out a loan without doing proper research and weighing the pros and cons is something no one should do. There are so many things to look at when signing a loan agreement. If you want to make sure you are making the right move and not taking a big risk, below is a list of questions to ask before opting for an unsecured loan:
1. How much do I need?
Before you rush to a lender to get an unsecured loan, sit down and calculate how much you need. Borrowing too much might make it hard for you to pay it back. The thing with borrowing money from lenders is that they put interest on the amount you borrow.
This means that you won’t be paying back the amount you borrowed, but that amount plus the interest. Since it is an unsecured loan that we are talking about, they have high interest. So, at the end of the loan term, you will be paying a lot more. That’s why it is best to borrow exactly what you need and nothing extra.
2. What is the Repayment Term?
When you borrow money, you need to return it within the time specified by the lender. In most cases, lenders and borrowers negotiate the loan term that is suitable for both. One of the most important things to know is whether it is okay to repay the loan before the specified time or not. Many times, lenders penalise borrowers if they pay the loan off early. This happens because they miss their chance of earning additional interest so they put a fine on the borrower.
These things are a must to know before you opt for an unsecured loan or any type of loan for that matter. You should also take care of the monthly payments and never miss them.
3. How does Interest Rate Work?
Regardless of the type of loan you are borrowing, it is essential to learn about the interest on it. If you talk about unsecured loans, it is not the ideal loan to get a lower interest rate. In fact, an unsecured loan has the highest interest rate due to its nature.
Unsecured loans aren’t backed by collateral, which means that the lender is taking full risk. In a bid to protect themselves from loss, lenders of unsecured loans charge high interest. So, if you are not willing to pay a high amount each month, this is not the type of loan you should opt for.
When you understand this, it is time to talk to your lender about the interest rate. Ask him how the interest is calculated and charged. Ask him if it is variable or fixed. Your lender might be flexible in choosing an interest rate type. So, always negotiate better terms with your lender.
4. What happens when I Fail to make Monthly Payment on Time?
Lenders take monthly payments very seriously and so should the borrowers. When you take out a loan, you pay a monthly fee plus the interest rate. However, if you fail to make the payment, you will get in trouble. How much trouble you get in depends on your lender. So, when getting a loan, make sure you talk to your lender about late payments and ask them about the penalty.
Many borrowers fail to read the agreement document before signing it and end up paying hefty fines for late payments. In many cases, interest rate changes when you are late in paying your dues.
5. What Documents do I need?
No matter what type of loan you are applying for, you need to make sure you have gathered the right documents beforehand. Without proper documentation, you might lose your chance of getting approved for any loan at all. If you are applying for an unsecured loan, you will need to provide your income statement, employer’s letter, credit score, etc.
These things are required by the lender to ensure you are safe to lend money. If any of the things don’t add up, your application will be denied.
6. Should I be worried about my Credit Score?
If you are borrowing an unsecured loan, you should be worried about your credit score. Unsecured loans do not require collateral, which means that your loan isn’t secured by anything. Lenders look at borrowers’ credit score to ensure they are not giving money to someone who cannot afford to pay it back.
It is best to request a copy of your credit report from one of the three credit bureaus. After receiving the copy, you must check it to make sure that all the information is accurate. In case there’s an error in any entry, you can get in touch with any of the three credit bureaus to request a correction.
Remember, your chances of getting an unsecured loan will increase only if you have a good credit score. What’s more; those with a good credit score can enjoy lower interest rates.
What’s Good about Unsecured Loans?
Unsecured loans are costlier, but they are less risky. These loans do not keep you feeling stressed over losing your home or vehicle. An unsecured loan can be a personal loan, a business loan, or a student loan.
Since you do not back the funds with collateral, you pay a high price for it. But that’s not all. Unsecured loans can be quite beneficial, especially if you want to spend the money as you desire. The lenders of unsecured loans do not ask how you plan to use the money. All they are interested in is that you make the monthly payments regularly.
Unsecured loans can be borrowed by businesses as well. Unsecured business loans are not different. All the lender needs to know is that your business is successful and you earn good money every month. The lender will look at your credit report and credit card sales to ensure you have the capability to pay it off in time. These loans are low risk for businesses since they do not use collateral, keeping them stress free.
The Bottom Line
Loans are divided into two main categories; secured loans and unsecured loans. If you are not thrilled by the idea of using your assets as collateral, it is surely an unsecured loan that you should opt for. But be prepared because unsecured loans are quite expensive. The amount you borrow increases over time with the addition of interest.
An unsecured loan is mostly beneficial, but can turn risky if you do not inquire about it and sign the agreement without knowing it inside out. With the help of the tips mentioned in this article, we hope you can make the best choice.