The whole idea of credit is built around mitigating risk. Risk is the chance that a lender will not get their money back from the borrower. This is the lender's worst nightmare. To protect themselves from risk, lenders charge interest on the money borrower. This interest is expressed as a percentage applied to the balance of the loan annually. The thing about interest is that it compounds with time. $10,000 loaned for one year at an interest rate of 2.25% applied monthly will result in the amount owed growing to $12,700 by the end of the year.
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Loans made to borrowers always carry an element of risk with them. The lender takes various steps to protect themselves from the risk of borrowers not being able or willing to repay their loan. One of these ways is to demand that the borrower provides the lender with the right to seize an asset in the borrower does not repay their debt. If the asset in question is a house, the loan is a mortgage. If the asset is a car, the loan is an auto loan. These loans are known as secured loans because the asset is said to provide security for the lender.
There are also unsecured loans, which are not backed by any asset and are loaned purely on credit. These loans are more dangerous for lenders, and consequently the interest rates on this loans are higher. This is a downside to unsecured loans because the borrower is required to pay more interest to the lender in order to compensate for the increased risk. The immediate benefit to the borrower is the fact that the borrower does not have to provide an asset in exchange for the money, which is a relief to borrowers who are strapped for cash but have few assets to provide.
Another aspect to unsecured loans that is both an upside and a downside is the fact that approval is entirely contingent upon credit. This is good news for the borrower that has good credit, but bad news for the borrower that has bad credit. The credit rating of the borrower is the determining factor concerning approval for an unsecured loan. The borrower needs to be aware that maintaining a good credit rating is essential to getting approved for all loans, not just unsecured loans, although with unsecured loans good credit is especially important.
In the final analysis, unsecured loans are advantageous if the borrower can afford the extra interest and if they are in need of immediately access to liquid funds. Borrowers are wise to stay away from unsecured loans if they know that there is a good chance that they will not be able to repay them.
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