An unsecured loan is a loan that is issued and supported only by the borrower's credit worthiness, rather than by any type of collateral. An unsecured loan is one that is obtained without the use of property as collateral for the loan, and it is also called a signature loan or a personal loan.
Because an unsecured loan is not guaranteed by any type of property, these loans are bigger risks for lenders and, as such, typically have higher interest rates than secured loans such as mortgages or car loans.
Unsecured loans include credit cards, student loans and personal loans, and these loans can be revolving or term loans. A revolving loan is a loan that has a credit limit that can be spent, repaid and spent again. Examples of revolving unsecured loans include credit cards and personal lines of credit.
Term loans, in contrast, are loans that the borrower repays in equal installments until the loan is paid off at the end of its term. While these types of loans are often affiliated with secured loans such as mortgages and car loans, there are also unsecured term loans. A consolidation loan to pay off credit cards or a signature loan from a bank would be considered unsecured term loans.
Alternative lenders such as payday lenders or companies who offer merchant cash advances do not offer secured loans in the traditional sense of the phrase. Their loans are not secured by tangible collateral as mortgages and car loans are. However, these lenders take other measures to secure repayment.
In particular, payday lenders have borrowers give them a postdated check or agree to an automatic withdrawal from their checking accounts to repay the loan. Many online merchant cash advance lenders require the borrower to pay a certain percentage of his online sales through a payment processing service such as PayPal. As a result, these loans are considered unsecured, although they are partially secured.
If a borrower defaults on a secured loan, the lender can repossess the collateral to recoup his losses. In contrast, if a borrower defaults on an unsecured loan, the lender cannot claim property. However, the lender has can take other actions, such as commissioning a collection agency to collect the debt or taking the borrower to court. If the court rules in the lender's favor, the borrower's wages may be garnished, a lien may be placed on the borrower's home, or the borrower may be otherwise ordered to pay the debt.