All About Unsecured Loan


What is an unsecured loan?

An unsecured loan is a type of credit in which you do not have to pledge any assets to obtain funds. After reviewing your income and credit profile, the lender decides on your eligibility and loan amount. Unsecured loans include credit cards, personal line of credit, student loans, personal loans, etc.

KEY TAKEAWAYS

  • Unsecured loans are available without the need for collateral.
  • Your credit history and income determine the loan amount.
  • The interest rates are higher due to increased credit risk.

Types of unsecured loans in India

There are three types of unsecured loans in India—Personal Loans, Business term loans, and Revolving credit. Let us learn about each of these loans.

1. Personal Loans

These are the most common form of unsecured loans in India and are accessible with just a few clicks. Personal Loan interest rates are typically higher due to the risk involved in lending. However, if you have a steady income and work for a reputed employer or have a well-established business, you may be able to obtain an affordable rate. Another advantage of this loan is its versatility in terms of application. You may use the funds to meet any financial requirement without informing the lender. This loan is widely used to cover the following expenses.

  • Wedding expenses
  • Debt consolidation
  • Education expenses
  • Medical emergency
  • House renovation and decor

2. Business term loans

Business Loans are available in the market in customised forms. You can find this loan in both unsecured and secured forms. For example, you are not required to provide collateral while applying for a term Business Loan. Further, you can use the money to cover any business-related expenses. The lender approves this loan after reviewing your company’s creditworthiness, financial records, business plan, and business vintage. Some of the most common reasons why entrepreneurs apply for this loan are:

  • Raw material purchase
  • Business expansion
  • Business expansion
  • Machinery purchase
  • 3. Revolving credit

    Revolving credit is a type of unsecured loan in which the lender determines your credit limit based on your repayment potential. You may withdraw funds up to the specified limit, and interest is charged only on the amount withdrawn, not the amount credited. As soon as you start repaying your debt, the extent to which you repay the principal amount is restored to your credit limit. Some of the common examples of revolving credit are credit cards, line-based personal loans, and business lines of credit.

Benefits of unsecured loans

Unsecured loans have various benefits, some of which are defined below.

Available without collateral:

As the name suggests, unsecured loans do not require any security for loan approval. The lender won’t hesitate to sanction funds if you have a strong credit profile. Additionally, if a financial crisis occurs, causing you to default on your loan, you will not lose your possessions. Unfortunately, your credit score will suffer significantly, and you may never be approved for a loan again.

Quick approval:

Since this loan does not require collateral, the time spent by the lender’s executive inspecting and determining the asset value is saved. The lender immediately performs risk profiling using advanced Artificial Intelligence (AI) and Machine Learning (ML) technologies. As a result, you will know within minutes whether you qualify for a loan or not.

Multi-purpose loans:

Almost every unsecured loan allows for application flexibility. You may use the funds for any lawful business or personal purpose. For example, a Personal Loan amount of ₹10 Lakh can be used for home decor and business stationery simultaneously.

Disadvantages of unsecured loans

It is crucial not to overlook the following drawbacks of unsecured loans.

Strict eligibility requirements:

Unsecured loans pose a significant risk to lenders. Since the lender has no other option but to pursue legal action in the event of a default, the eligibility criteria are strict. It means you must have a good credit score and a debt-free or lower debt-to-income (DTI) ratio to qualify for this loan.

Higher interest rate:

The lender charges a higher interest rate to limit the amount of loss they may incur if you default.

Shorter repayment tenure:

Unsecured loans typically have a shorter repayment tenure. For example, in the case of Personal Loans, many borrowers offer repayment terms of up to 60 months. If you choose revolving credit, the repayment period can be as short as two months.

Smaller loan amount:

Unlike secured loans, where the fund value is determined by the property value, and the loan-to-value (LTV) ratio can go up to 90%, unsecured loans are available for a smaller amount ranging from a few thousand rupees to ₹30 Lakh.

How do unsecured loans work?

When you apply for an unsecured loan, the lender will ask you to provide all necessary financial documents, such as pay slips, bank account statements, and business financial records (for entrepreneurs). They then conduct a hard credit check by requesting your credit report from a credit bureau. The credit report includes information about your current debts, previous loans, the total amount you are currently paying in EMI, your default history, moratorium, and so on.

Then they start evaluating your report and furnished documents to conduct risk profiling. In case they find anything negative on your credit report or discover that your current income is insufficient to cover a new loan EMI, they will reject your application. In case they approve you, you will be charged a high-interest rate.

Secured vs Unsecured loan

Parameters Unsecured loan Secured loan
Collateral This kind of loan is available without collateral Collateral is mandatory, and the type of collateral needed depends on the loan you are applying for
Interest rate Interest rates are high due to increased credit risk Interest rates are lower because the funds are secured by a valuable asset
Documentation You will only need KYC and income proof to obtain this loan In addition to KYC and income proof, asset-related documents are required. In some cases, insurance paper for pledged/mortgaged assets is also mandatory
Loan amount Smaller loan amount Higher loan amount
Repayment tenure Repayment terms can range from a few months to up to five years, depending on the loan type Repayment terms can be as long as 30 years (in the case of a Home Loan)
Processing time Funds are disbursed quickly Approval takes a little longer due to the physical inspection of the pledged asset in question
Upfront cost You only need to pay the processing fee when you submit your application You will have to pay property valuation fees in addition to the processing fee
Examples Personal Loan, term Business Loans, and revolving credit Loan Against Property, vehicle loan, Home Loan

End-uses of an unsecured loan

As previously stated, unsecured loans provide end-use flexibility. The lender does not require you to provide a reason for applying for the funds on the loan application. They also do not impose any restrictions unless and until you use the funds for legal purposes. You can use this loan to grow your business, buy a personal or commercial vehicle, pay for wedding expenses, finance your retirement, deal with a medical emergency, and so on. However, remember that if you apply for a term Business Loan, the funds can only be used for business-related expenses.

Final words

Unsecured loans are appropriate if you require funds quickly and do not have any assets to pledge to secure a lower interest rate. This loan is popular among many because of its end-use flexibility and ease of access. However, you must also consider the disadvantages of this loan before taking the final call.

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