Definition: An unsecured loan is a debt issued with no collateral attached. To state it differently, it is a loan that has no other guarantee than the borrower’s creditworthiness.
What Does Unsecured Loan Mean?
Unsecured loans are issued by financial institutions to both individuals and corporations for many different purposes. These loans are not collateralized, which means that there is no asset backing the loan. By having no collateral, they pose a higher risk for the financial institution issuing them, since in the case the client defaults the payment, there’s nothing that ensures the institution that they will get at least some of its money back.
Unsecured loans are backed by the positive credit record of the borrower; this means the financial institution backs the loan with just a promise of payment signed by the client. In the event of a default, the institution will have to write off the loan as a loss since there is no collateral to be sold to fulfill the financial commitment. Credit cards are a good example of an unsecured loan, since they have no collateral attached.
Let’s look at a practical example.
Mr. White is an account holder at Big Money Bank LLC. He is currently applying for a loan to make some purchases to remodel his home. He has an excellent credit rating and he thinks he can get $5,000 for the project. The bank is offering him a loan for a period of 48 months with an interest rate of 3% a year. The bank’s representative informed Mr. White that he doesn’t need a guarantor and there’s also no collateral required to get the loan approved. Which kind of loan is this?
According to our previous definition, an unsecured loan is a debt issued with no collateral attached. As we can see in this situation, by not requiring a guarantee or a guarantor the bank is actually lending the money to Mr. White trough an unsecured loan.