A personal loan is another term that is used to describe unsecured debt. Under a personal loan, you take out money based on the promise that you’re going to pay it back. There’s no guarantee for the creditor, so the creditor has to offset this higher amount of risk they’re taking, usually with a higher amount charged for fees. The personal loan arrangement is not a good one for large amounts of money.
What Are They For?
Personal loans are usually taken out for small purchases. For example, if your computer dies and you need to get a new one, a personal loan may be the most desirable way to get the funding. Because you’re not borrowing a great deal of money, the high interest and high fees associated with these loans are acceptable. These loans come in many forms; here are some examples:
- Store credit to buy consumer goods
- Store credit cards that serve as revolving credit
- Signature loans
- Payday loans
Why Are the Fees High?
When creditors give personal loans, they’re taking a lot of risk. There’s basically nothing they can do aside from turn the case over to a collection agency if the debtor decides to default on the loan. They may take the debtor to court, as well, but they’re still taking a huge risk in that the debtor simply may not have enough money to pay them back and because the creditor has no right to any property in exchange for the money not paid.
A secured loan protects the creditor by giving them a lien on a piece of property. The creditor’s credit rating and their personal guarantee to pay the loan back does play a role in a secured loan, but the debtor can always simply take the property used for collateral or repossess the property bought with the loan if a secured loan is defaulted upon. In the case of an unsecured loan, it’s all about the debtor’s creditworthiness.
If you’re interested in taking out an unsecured loan, be sure you understand how to use these financial instruments wisely. They’re great for making small purchases that you can pay back quickly or, at least, within the terms for which the loan is written. Over a certain amount, however, the loans become burdensome because of their high interest rates and the other fees associated with them. Like all financial instruments, an unsecured loan is incredibly useful for some situations and very inappropriate for others.
