Additional Resources

  1. Economics & Statistics Discussion Paper No. 21/04 [citeseerx.ist.psu.edu]
  2. The Law And Economics Debate About Secured Lending ... [citeseerx.ist.psu.edu]
  3. Adverse Selection And Maturity Choice [econ.as.nyu.edu]
  4. Solutions For End-of-chapter Questions And Problems: Chapter Eleven [leeds-faculty.colorado.edu]

Definition

In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment.

Unsecured Loan

An unsecured loan is a type of loan that is obtained without offering any collateral, and is supported only by creditworthiness of the borrower. The loan is usually offered to individuals having a high credit score. However, some loan issuing companies also offer these loans to individuals having not-so-perfect credit history.

Characteristics of an 'Unsecured Loan'

Unsecured loans are not backed by any personal property of the borrower. The loans carry a high risk for the lender. In order to offset the risks, credit companies usually charge a high rate of interest on the loans. That being said, the rates charged on the unsecured loans are generally lower as compared to those of credit cards. Interest that is charged on an unsecured loan is not tax deductable, similar to mortgage loans.

An unsecured loan may be a perfect choice for individuals that do not have enough assets to back the loan, but nonetheless desperately need to loan to meet financial obligations. The loan may entail a fixed or a variable interest rate. Two common classes of unsecured loans include payday loans and working capital loans.

In the event a borrower defaults, the unsecured lenders will have a general claim on the property of the borrower after all the obligations of secured lenders are fulfilled. They usually are able to realize a very small portion of the assets.

Creditors that offer unsecured loans usually charge high fees in addition to the interest rates. The high fees and charges are levied to offset some of the risk due to default of the borrower. Most of the borrowers resort to this type of loan as a last resort when they have exhausted all the options. They are willing to pay the high charges to obtain the cash needed for meeting essential expenses.

Most of the times the unsecured loans are sought by a company when it requires additional capital and the existing assets have been utilized to secure prior debts. Unsecured lenders usually add a clause in the loan agreement that prevents the debtor from taking on additional debts until the unsecured loan is repaid.

Requirements of Obtaining Unsecured Loans

Creditors put certain requirements that must be fulfilled to obtain the unsecured loan. These include having a minimum specified salary, providing a proof of income, giving copy of identification such as valid driver license, passport etc., and show proof of residence. Individuals that fulfill these criteria are credited the loan amount directly in the bank accounts.

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