Let’s say a friend wants to borrow some money from you. They are employed, pay their bills on time, and don’t carry a lot of debt. You might feel comfortable loaning them money without asking for any type of collateral. Collateral is something of value your friend would pledge to secure the loan and forfeit if they failed to repay the loan. This example is a good illustration of an unsecured loan. Banks and other lenders also offer unsecured loans, using a variety of metrics to determine creditworthiness.
Unsecured vs Secured Loans
The main difference between an unsecured and secured loan is collateral. Unsecured loans do not require you to pledge collateral, which can include your home, vehicle, other property, or money in a savings account, against the note. Because the lender does not need to review collateral assets, the approval process for unsecured loans may be faster than with secured notes. However, since the lender’s risk may be greater without collateral, you may also pay a higher interest rate, and there may be a lower limit on your loan amount.
How to Qualify for an Unsecured Loan
If you want to know whether you will qualify for an unsecured loan, you may want to review the factors that lenders consider before you apply:
- Credit History: The lender will typically pull your most recent credit report to check how much debt you carry and whether you pay your bills on time. Reports generally go back seven to ten years and include both positive and negative information. Positive information includes active and closed accounts you have paid as agreed. Negative information includes bankruptcies, repossessions, accounts placed into collection, and late payments. While an occasional late payment doesn’t typically mean you won’t qualify for a loan, be prepared to explain the reasons why you made a payment late.
- Credit Score: One of the most important factors when you apply for an unsecured loan will be your credit score. If you have a FICO score of 620 or higher, you may have a better chance of approval. Keep in mind that a lower credit score may result in higher interest rates as well as potentially lower loan amounts. Before you apply for any type of loan, you may be able to check your credit score for free using credit monitoring resources made available through your bank, credit union or through your credit cards. You may also want to pull a free copy of your annual credit report. Review the information and address any errors before you apply for your loan.
- Debt-to-Income Ratio: There will be limits on how much you can borrow based on a formula the lender uses called the debt to income ratio, or simply the “debt ratio.” Your debt ratio is calculated by dividing certain monthly debts by your gross monthly income (income before taxes). Acceptable debt ratios and calculation methods vary by lender, but to qualify for an unsecured loan with some lenders, you may need your debt ratio to be 36 percent or lower.
How to Qualify for a Secured Loan
With a secured loan, the lender reviews your credit score, credit history, and debt-to-income ratio just like they would for an unsecured loan. Based upon that review, the lender can determine acceptable collateral for you to pledge for the loan. If you pledge a vehicle, for example, they may want to have it appraised for its current value. With some loans, you may be able to pledge money in a savings account or a certificate of deposit. Using savings as collateral means you may forgo your ability to access those funds until the loan is repaid.
Which Type of Loan Is Right for You?
If you have a great credit history and feel confident you can make your monthly payments, you may want to offer collateral to take advantage of potentially lower interest rates often available with a secured loan. You may also be able to negotiate a competitive rate or terms if you have a high credit score. Weigh all your options before you apply for any loan.
Looking for a lender who understands your specific needs? Contact Mariner Finance today to apply for a secured or unsecured personal loan.
The information provided in this article does not constitute financial advice and is provided for educational purposes only without any express or implied warranty of any kind. This article is not intended as legal, tax, investment, or any other advice, and Mariner Finance does not offer credit repair services. Consider talking with an appropriately qualified professional for specific advice.