Understanding unsecured credit vs. other types of credit
What is unsecured credit?
Unsecured credit refers to a loan that is not backed by collateral. It might include a personal loan from your bank, a revolving line of credit associated with your credit card, or another form. Each line of credit has unique terms. The limits may range from a few thousand to a few hundred thousand dollars.
Some types of unsecured loans come with annual and other fees. Since the loans are unsecured, there is more risk for the lender. Higher risk means that you might expect to pay a higher rate of interest than you would with a secured loan. The most common form of unsecured credit is an unsecured credit card.
How does an unsecured loan work?
Unsecured loans normally require higher credit scores than secured loans. For example, debt consolidation loans are unsecured loans that may require higher credit scores than home equity lines of credit, which are secured loans.
If borrowers default on their unsecured debt payments, the lender cannot claim the property. For example, if a borrower defaults on his or her debt consolidation loan that is unsecured, the lender will not be able to claim any property to repay what is owed. However, the lender is able to hire a collection agency to collect the unsecured debt or can sue the borrower.
If a lender wins a lawsuit for unsecured debt, the borrower’s wages may be garnished. The borrower may also have a lien placed on his or her home, or the borrower may face other orders to repay what is owed for the unsecured debt.
Personal loans are an example of unsecured loans. You may be able to get unsecured loans from your bank or other financial institution if you have good credit. These unsecured loans are different from collateral loans because the loans are not secured by any personal or real property.
Americans and debt
Americans are deeply in debt. The total amount of debt held by Americans has reached $13.2 trillion. The Federal Reserve reports that people who are college-educated hold an average of $8,200 in unsecured credit card debt. By comparison, those who did not graduate from college have an average of $4,700 in credit card debt.
The total amount of unsecured credit card debt held by Americans is more than $830 billion. An estimated 70% of American adults have at least one credit card. These cards carry high rates of interest and should not be relied on to finance purchases. Instead, people should be judicious in their use of credit cards and try to repay their balances in full each month.
Types of unsecured credit
There are several types of unsecured credit, including the following:
- Unsecured loans
- Unsecured credit cards
- Personal loans
- Unsecured student loans
- Unsecured lines of credit
When people take out unsecured loans, they receive a lump sum of money. They must begin making payments in fixed installments for a set period of time. Interest begins accumulating immediately, regardless of when the money is used.
With unsecured credit cards, credit is extended on the basis of the borrower’s promise to repay without any collateral. Interest is charged when the borrower does not repay the full balance on his or her card by the end of the month. The money that is available is set up to a certain limit.
Personal loans do not require any collateral and can range from $1,000 to more than $50,000. These types of loans are repaid in fixed payments. The payment term for most personal loans is from two to five years. The rates and terms vary based on your credit.
Unsecured student loans are loans that people take out to pay for higher education expenses. The government charges an interest rate that is set by Congress. If the unsecured student loans are from a financial institution, the interest rate will be dependent on your credit score. Some student loans permit using cosigners.
An unsecured line of credit gives the borrower access to a set amount of money that can be borrowed when it is needed. You will only pay interest at the time that you borrow money from your credit line. Once you repay the amount that you have borrowed, the same amount is available again to you. Unsecured lines of credit may include personal lines of credit, business lines of credit, and demand lines of credit.
Personal lines of credit provide you with access to a specific limit of money. You can use the money from a personal line of credit as needed for any purpose. These have lower interest rates than credit cards, which makes them a better choice for borrowing. To get a personal line of credit, you will need a good credit score and a good credit history.
Business lines of credit provide credit to businesses on an as-needed basis instead of as a fixed loan. The financial institution evaluates the market value, profitability and risk taken on by the business and extends a line of credit. The line of credit may either be unsecured or secured, depending on the size of the requested line of credit and the overall evaluation of the business. Business lines of credit charge variable interest rates.
Demand lines of credit can be secured or unsecured. This differs in that the lenders are able to call in the loan at any time. The terms of payments can vary widely. They might be interest-only or interest plus principal. The borrower is able to spend up to the credit limit at any time. Demand lines of credit are fairly uncommon.
Secured credit
Secured credit is different than unsecured credit. If you have collateral loans and are unable to make your payments, the lenders can take the assets that secure the collateral loans.
Home equity lines of credit or HELOCs are common types of collateral loans that use your home to secure the line of credit. These allow you to borrow against the equity that you have available in your home. HELOCs have variable interest rates, which means that you may have an increase in your payments over the life of the credit line.
Some borrowers use HELOCs as debt consolidation loans because they may have lower rates of interest than credit card and other types of unsecured debt. However, it is important to be careful if you choose to use your HELOC as a debt consolidation loan. Some people end up running up their other debt balances after repaying them with their HELOCs, meaning that they will be further into debt than when they started.
You should only borrow what you need when you need it. The amount that might be available to you will be limited. Normally, you can borrow up to 85% of your home’s appraised value minus the balance that you owe on your first mortgage. You can obtain a better rate of interest if you have the highest credit score and a good income and you may be able to deduct the interest that you pay on your HELOC on your tax returns.
Some people have secured loans that use their savings accounts or certificates of deposit as collateral. With these types of loans, the lender may take the balance of your savings account or of your CDs if you fail to make your payments.
Securities-backed lines of credit or SBLOCs are special types of LOCs that use the securities in your investment account as collateral. An SBLOC may allow you to borrow as much as 95% of your portfolio’s value, depending on your brokerage.
SBLOCs may not be used to buy or trade stocks and other securities. However, they can use the money for nearly any other expenditure. If you have an SBLOC, you will have to make interest-only payments each month until you have repaid your loan or until your bank demands full repayment. Full payment may be demanded if your portfolio’s value drops below your line of credit’s level.
Revolving credit
Revolving credit is an open-ended credit account that allows people to borrow money from the credit line. When they repay it, the money will be available for them to borrow again. Revolving credit lines are different from installment loans such as signature loans, student loans, debt consolidation loans, auto loans, and mortgages.
Consumers who have installment loans borrow a lump sum of money. They then must repay it in equal monthly installments until it is repaid in full. Once you have paid off an installment loan, the account will be closed. You will have to take out a new loan to gain access to more funds. In a revolving credit line, the funds are replenished once they are paid back. The funds can be borrowed again as long as the line of credit remains open.
Non-revolving credit
Non-revolving credit allows you to spend the money for any number of purposes after your credit limit has been set. People with the highest credit scores may get better interest rates and higher limits. Interest may be charged when the funds are used, and you can make your payments at any time.
When you have non-revolving credit lines, your available credit will not be replenished once you make payments. After it is paid off, your account will be closed.
Revocable line of credit
A revocable line of credit is credit that is provided to an individual or business by a bank or other financial institution. It can be canceled or revoked at the lender’s discretion.
A bank or financial institution may revoke a line of credit if the customer’s financial circumstances decline or if market conditions turn such that cancellation is warranted. A revocable credit line can be unsecured credit or secured credit.
Term loan
A term loan is a type of loan that is repaid in equal installments each month for a set period of time. Often associated with secured loans, there are also unsecured credit term loans.
There are a couple of types of term loans. Debt consolidation loans to pay off credit cards and other types of high-interest unsecured debts are term loans. Personal loans or signature loans are types of unsecured credit that are payable over a term.
To get these types of loans, people need to have the highest credit scores. Because personal loans, debt consolidation loans and signature loans are normally not secured by collateral, banks demand the highest credit scores from their borrowers.
Fees
Unsecured credit may come with fees such as an annual fee. There may also be limits placed on the amount of money that you can borrow. During the repayment period, you will repay the principal and interest on your loan. For some types of secured loans, you may have closing costs that vary depending on the lender. Closing costs are common for HELOCs.
Taking out unsecured credit
Before you apply for unsecured credit, check your credit score. If you have the highest credit score possible, your chance of qualifying and of getting a lower interest rate may be increased. Lenders assess your credit by checking your credit score.
The highest credit score falls into a range of 720 or above, which is considered to be excellent credit. Good credit falls into a range of 690 to 719. Fair or average credit falls into a range of 630 to 689 and bad credit falls into a range of 300 to 629.
Before you apply, take steps to try to obtain the highest credit score possible. Factors that affect your credit score include making on-time payments and having low debt relative to your income and credit limits.
Compare interest rates and payment amounts of different unsecured credit offers before you apply. Read the terms carefully. Look for penalties, rate increase terms, withdrawal rules and payment requirements. Most lenders require that you undergo credit checks and fill out paperwork to be approved for credit.
While you might have to deal with loan officers, fill out paperwork and undergo a credit check to be approved for unsecured credit, you can avoid most of the hassle by choosing to borrow from M1 Borrow instead. This is a flexible line of credit from your investment portfolio that allows you to borrow up to 35% of the value of your securities. You will not have to go through a credit check or to fill out reams of paperwork. When you borrow money from M1 Borrow, you are able to repay the funds on your own schedule at one of the lowest rates of interest on the market.
Borrow on your terms with M1
M1 offers the simplest, lowest-cost way to borrow money. M1 Borrow allows you to borrow up to 35% of your portfolio and to repay it at one of the lowest available interest rates.
You can use M1 Borrow to pay down expensive debt and it might be more tax deductible than most HELOCs. As long as you meet the account minimum requirements, you can instantly access a portfolio line of credit without filling out more paperwork, undergoing a credit check or dealing with a loan officer.
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