|By Jonathan Boral on January 22, 2010
In terms of financial loans, unsecured loans are some of the most difficult to explicitly describe, because there are numerous ways to obtain an unsecured loan. Many times, it is easiest to describe an unsecured loan through what it doesn’t secure; a loan through collateral. While many other types of loans hold collateral the lender can obtain if the loan is unpaid, unsecured loans do not have this same type of security.
Unsecured loans can many times be as basic as borrowing between friends. If a friend allows you to borrow money, it is not collateral or your credit score that is used to approve this loan, but more than often it is the value of your friendship which will determine whether or not you obtain that loan.
On a more structured route, banks will often times give out unsecured loans through an analysis of the borrower’s credit score. When applying for an unsecured loan, banks will determine if your credit score alone will prove that you would be capable of paying back the loan. Also, an unsecured loan means that banks will most likely not take a steady flow of income into account when determining if you are approved or not.
The three main types of unsecured loans are personal, business, and business with a personal guarantee. A personal loan is through an individual, when that individual promises to repay the loan. In a business unsecured loan, the entire business is responsible for the repayment of the loan. What makes a business loan with a personal guarantee different is that the business is responsible for repaying that loan, but if the business were to default on that loan, one individual would then be responsible to repay the lender.
To determine the interest rate on an unsecured loan, banks will often factor in the amount of the loan and the amount of its risk. For example, a higher loan is bound to have a lower interest rate, because the bank knows they are receiving a large amount of business from the money you are borrowing. On the other hand, that rate could be increased if your credit score is high; meaning it is a higher risk for that bank to serve you because you are less likely to pay back the loan. Each rate will be individualized to the situation.