Unsecured Debt
Candlefocus EditorUnsecured debts, unlike secured loans, are not tied to any collateral and therefore, they offer no guarantee of repayment beyond what is stated in the debt agreement. This is why lenders will often charge higher interest rates with unsecured loans in order to compensate for the higher risk.
Generally, unsecured debts are commonly available in the form of personal loans, credit card debt, and student loans. Similarly, lenders of unsecured debt will often require borrowers to have a good credit score or to otherwise show their creditworthiness before they can secure the loan. Lenders may also check the borrower’s debt-to-income (DTI) ratio to ensure that the borrower is able to afford making the necessary payments.
In order to mitigate the risk of defaulting on their unsecured loans, lenders can employ several strategies, including reporting defaults to credit rating agencies, contracting with credit collection agencies, and selling their loans on the secondary market.
Lenders may also charge late fees and punitive interest rates to borrowers that have missed payments, have engaged in multiple missed payments, or have a particularly high DTI. This provides an additional deterrent to borrowers considering defaulting on their loans.
Unsecured debt can be a useful way to finance a project, purchase, or investment, but borrowers must always approach these types of loans with caution and only if they feel confident that they will be able to make payments on time. Ultimately, when used responsibly and with the lenders’ mitigation strategies in mind, unsecured debt can be a viable financing option for those with the necessary credit ratings.