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PERSONAL FINANCE LOAN BASICS

Unsecured
By JULIA KAGAN | Updated Jun 15, 2018

What is Unsecured
Unsecured loans or lines of credit (LOC) are loans where lending happens without the backing
of equal value collateral. Collateral is property or other valuable assets which a borrower offers
as a way to secure the loan. In an unsecured loan, the lender will loan funds based on other
borrower qualifying factors. These qualifying factors include the credit history, income, work
status, and other existing debts.

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BREAKING DOWN Unsecured

Unsecured loans present a high risk to lenders. Because there is no collateral to take as recourse
if the borrower defaults on the loan, the lender has nothing of value to claim against, and cover
their costs. Default happens when the debtor is unable to meet their legal obligations to pay a
debt. Instead, of demanding the collateral, the lender will need to turn to civil actions. Such
actions include hiring a collection agency and filing a lawsuit to recoup unpaid balances. 

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Unsecured loans and lines of credit (LOC) often have high-interest rates. These rates help to
insulate lenders against the risks of loss. The most common forms of unsecured funds are credit
cards and personal loans.

Differences between Unsecured and Secured Loans

Many people are already familiar with secured loans in the form of mortgages and auto loans. In
both of those cases, the seizing the collateral which secures the loan can happen in the event of
a default. For mortgages, this occurrence is called a foreclosure. Once a borrower has missed a
payment the default process has begun. The servicer will complete the legal requirements on
their end to reclaim the property which secured the mortgage.

In the case of an auto, boat, or other large equipment loans, this process is repossession. In
both foreclosure and repossession, the borrower will lose the item which secures the loan.

Secured loans or debt have limits set by the value of the collateral offered. When it comes to a
home mortgage, a borrower may only receive a portion of the total fair market value of the
property. Auto, boats, and other loans also follow this pattern.

Problems with Foreclosed Flooding

With the 2006 housing market crash, foreclosed properties flooded the market. This massive
influx of homes drove the value of all houses downward. Before the crash, home values
increased exponentially, making a bubble. When the housing market bubble burst, the problem
was two-fold. 

First, the surplus of houses led to lower overall home values. Because, like all products, more
demand commands increased prices, while more supply than demand forces prices
down. This drop in value caused the second shoe to drop. Homeowners seeing the worth of
their investment fall hoped to sell. Due to the amount of ready supply, they often found this
difficult, if not impossible to do. They, in turn, begin to default on their mortgages.

The banks reclaimed these properties and then found that they could not sell them either.
Some of those banks went under as a result, which provided an example of how even secured
loans can be risky business. Lending terms have changed dramatically since the 2006 housing
crash, and banks are now more conservative as a result.
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Related Terms
Security Interest
Security interest is a legal claim on collateral that has been pledged, usually to obtain a loan, that gives a
creditor the right to repossession. more

Unsecured Loan
An unsecured loan doesn't require any type of collateral, but to get approved for one you'll need good
credit. more

Deficiency Balance
A deficiency balance is the amount owed to a creditor when collateral is sold for an amount that is less
than what is owed on the secured loan. more

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Second Mortgage
A second mortgage is a mortgage made while the original mortgage is still in effect. Learn the
requirements for a second mortgage and how to apply. more

Single Interest Insurance

Single interest insurance, also known as vendor single interest insurance or VSI insurance, protects the
lender but not the borrower in a home or car loan. more

Secured Loans Explained

Secured loans are loans that require collateral to borrow. Here’s how secured loans work and where to
find them. more

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