What Is an Unsecured Loan?
An unsecured loan
is a loan given to a borrower without them providing collateral, such as a real estate asset, to guarantee the loan. Loan amounts for unsecured loans typically range from $1,000 to $50,000.
A secured loan is when you borrow money by securing the loan with an asset, such as a house. Examples of secured loans include mortgages and auto loans.
With an unsecured loan, money is lent based on the borrower’s creditworthiness. That’s why a loan applicant’s credit history and credit score play an essential role in whether the lender approves them for an unsecured loan. You may be unable to get an unsecured loan if you have bad credit or a poor credit rating.
There are a few types of unsecured loans:
Credit cards are unsecured loans because a lender—usually a bank—extends you a line of credit based on your credit score. You borrow money each time you use the credit card.
A personal loan is an unsecured loan that’s issued to a borrower for use as they see fit. Whereas a mortgage helps buy a house, a personal loan doesn’t come with usage requirements. Borrows can use personal loans for things like debt consolidation or home improvement. For this reason, people sometimes refer to an unsecured loan as an unsecured personal loan.
Student loans are often unsecured loans. Lenders issue them to borrowers based on their credit reports with no collateral required.
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How Does an Unsecured Loan Work?
The most common lenders of unsecured loans are banks, credit unions, and online lenders. These lenders evaluate unsecured loan applicants based on their credit history, income, and the loan amounts they’re requesting.
When you apply for an unsecured loan, the lender will review your credit rating. Lenders also check your income. They’ll ask you to provide proof of income, such as your tax returns or bank account statements, when you apply for the loan.
Approval for an unsecured loan usually takes less time than for a secured loan. The unsecured loan application process requires fewer documents and steps to complete. For example, a mortgage
requires a credit check, income verification, as well as a home appraisal, title search, and homeowner’s insurance.
Because unsecured loans are collateral-free, they often come with higher interest rates than secured loans.
You may not get approved for an unsecured loan if you don’t have good credit. If approved, your credit score helps determine your loan terms, including interest rates and monthly payments. Even if you qualify for the loan, if you have a poor credit history, the lender may charge you higher interest rates.
Once approved, you’ll receive the loan amount as a lump sum. If a lender approves you for an unsecured personal loan, the amount for which you applied will deposit into your bank account. You’re then free to use the money as you want. But you’re also required to begin making monthly payments on the loan amount.
If the lender doesn’t approve your loan application, you can try again using a co-signer. A co-signer is someone who applies for the loan with you, pledging responsibility for repaying the lender if you default on the loan. If you choose this path, you should use a co-signer with a higher credit score than you to improve your chance of approval.
Another option is to ask for less money. A lender may approve your unsecured loan application if you lower the loan amount.
How Is an Unsecured Loan Different From a Mortgage?
There are a few ways in which an unsecured loan differs from a mortgage.
First, a mortgage is a loan used to buy a property. As such, a mortgage uses the property being purchased as collateral to secure the loan. In other words, if you default on the mortgage, the lender can seize the property.
Also, a mortgage has a predetermined use. You must use a mortgage to buy a property. With an unsecured loan, no such stipulation exists. You can use unsecured loan money any way you want.
Other key differences between mortgages and unsecured loans include the loan terms. For example, mortgages often have lower interest rates than unsecured loans.
Mortgages can provide large sums of money that you use to pay for the buying and rehabbing of a property. Unsecured loans, though, are usually for less than $50,000. And lenders typically ask you to pay back unsecured loans within six or seven years. Mortgages, meanwhile, can extend for up to 30 years.
Lenders also usually approve mortgages from borrowers with lower credit scores than they do for unsecured loans. This approval is because lenders view mortgages as less risky than unsecured loans. If a borrower defaults on a mortgage, the lender knows they can seize an asset, as opposed to an unsecured loan.
Unsecured Loans Pros and Cons
There are several pros and cons to unsecured loans.
First, the pros:
You get money from an unsecured loan more quickly than with a secured loan. Unsecured loans require fewer steps and documents than secured loans. In some cases, online lenders issue the loan amount within 24 to 48 hours of an unsecured loan’s approval.
You can use an unsecured loan however you want. Secured loans usually have stipulations about their use, but that’s not the case with an unsecured loan.
The lender can’t seize your property if you default. With a mortgage, failure to make your loan payments can result in the bank taking your home. An unsecured loan, though, doesn’t use an asset to guarantee the loan. This lack of security means the lender can’t take your home or car, for example, if you fail to pay back the loan.
At the same time, there are essential cons with unsecured loans you should remember:
Interest rates are often higher. These higher interest rates are the downside of not securing a loan with collateral. The lender needs to protect themselves in case of default, and they usually do so by issuing higher loan rates.
Many lenders charge an origination fee. This fee pays the lender’s expenses for processing your loan application. The origination fee is typically one to eight percent of the loan amount, but it varies by lender and based on your credit history and loan terms.
Defaulting on your unsecured loan will hurt your credit score. While a lender can’t seize your property if you fail to make your loan payments, they can report you to the three credit bureaus. This negative mark can diminish your chances of getting approved for a loan, either unsecured or secured, in the future.
The lender can also sue you for nonpayment. Along with reporting you to the credit agencies, lenders can take you to court for default on an unsecured loan. A judgment in the lender’s favor can result in you owing them the unpaid balance of the loan, accumulated interest, legal fees, and more.
How Unsecured Loans Can Help Real Estate Investors
There are a few ways unsecured loans can help real estate investors.
You can use an unsecured loan as a business loan. Since you can spend money you receive from an unsecured loan as you want, you can use it as you need for your business. An unsecured loan can provide you with startup capital, for example.
Or, maybe you need more cash to buy a property. You can use a mortgage, but you may not need that much money.
Let’s say you’re $30,000 short of making an all-cash purchase, buying a house outright. A mortgage is going to take longer to secure because it requires an appraisal and more. You might be able to get an unsecured loan, though, that will enable you to complete the transaction. You’ll get approved and receive the funds faster with an unsecured loan than with a mortgage. Also, unsecured loans don’t require a down payment.
And an unsecured loan can help you pay for rehabbing a property. A home equity
loan can fund your work, too, but the approval process is like that of a mortgage. You might instead be able to get an unsecured loan to finance the project. The time you save getting an unsecured loan instead of a home equity loan is time you can generate cash flow from your property.
The best approach is to use unsecured loans to help you achieve a financial goal in your real estate investment business. Can an unsecured loan help you make more money? If so, such a loan might be a smart choice.
But do the math before signing the loan documents. After learning the loan terms, you need to make sure the loan can help your business make more money. For example, let’s say you get an unsecured loan to fix-up a rental property. Is the loan’s interest rate low enough that you can pay the loan back while still earning a profit from your rental property?
Things to Consider When Applying For an Unsecured Loan
Another critical thing to remember is that the loan terms vary by lender. That’s why it’s essential to shop around before signing the loan documents. Here are some questions to consider when applying for an unsecured loan:
- Does the lender charge an origination fee?
- What are the loan terms?
- What’s the loan’s interest rate?
- What are the monthly payments?
- When will you receive the funds?
An unsecured loan can help you grow your real estate investing business, but it’s crucial to find a loan that fits your needs and numbers. Identify how the funds will help increase your cash flow. And make sure the loan terms fall within those parameters.