What is Unsecured Lending?

A. Leverkuhn

Unsecured lending is a kind of lending in which the money lent is not backed up by collateral. In most unsecured lending, the lender protects their investment by knowing the creditworthiness of the borrower. Different kinds of unsecured loans are popular in today’s financial world.

Unsecured lending has become more popular as more people use credit cards.
Unsecured lending has become more popular as more people use credit cards.

When it comes to borrowing money, lots of individuals and businesses needing quick capital can profit from having “borrower assets” available. For private loans, these assets can be composed of vehicles, or homes and other properties. A good example would be a home equity loan, or HELOC ( home equity line of credit) situation. It’s important for the borrower to know that these assets are subject to repossession in cases of “default” for nonpayment of a loan.

Unsecured lending takes several forms. For private loans, a large spectrum of unsecured loan types are backed by the consumer’s individual credit score. A collection of three credit scores from different agencies compose one total score, which is known as the Fair Isaac or FICO score, named after the company that maintains rating systems for the overall credit score number. Consumers often know their own FICO scores, and try to undertake financial transactions that will promote a higher score in order to get better interest rates on unsecured loans.

As the popularity of unsecured loans has grown, financial companies have scrambled to extend them in all kinds of ways. Credit cards, for example, are unsecured loans. The company extends a certain dollar amount of credit, often based on nothing but the consumer’s credit scores. That leaves the borrower with an unsecured loan with all of the standard interest rates associated with those types of loans.

One big problem with credit cards and other unsecured loans is the issue of whether lenders use the lack of collateral to rake in unfair amounts of interest. Generally, this is a private contract between a lender and a borrower, but lately governments have begun to look critically at some kinds of unsecured loan agreements that consumer advocates say can be tricky, and take unfair advantage of borrowers. Issues like this crop up around the general practice of unsecured lending, where some experts say that the incentives don’t necessarily promote personal financial solvency or long term wealth outcomes for the average household or individual. It’s likely that consumer advocates will continue to evaluate how governments could effectively regulate lenders to balance out some of the extremes found in some unsecured lending agreements.

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