What is an unsecured loan?
An unsecured loan is a type of debt instrument available to corporations and private individuals that enables funds to be lent out purely on the creditworthiness of the borrower. This means that the once the borrower’s credit profile is evaluated, the funds are transmitted without the borrower having to pledge property or other tangible assets as collateral. Because of this type of structure, unsecured loan terms are contingent heavily on the borrower’s credit score. A high credit score can mean favourable terms in the form of lower interest, while a lower credit score can push up the interest level as the lender seeks compensation for the extra risk involved.
All things equal though, it is important to note that unsecured loans will always have higher rates than secured loans. In a secured facility, the lender can recoup losses by selling the borrower’s pledged assets. However, in an unsecured loan, if the loan is not recourse to the borrower’s personal assets, there is no way for the lender to recoup the loss. For this extra level of risk that they undertake, lenders thus charge higher rates of interest.