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Last updated on 21st of February 2022

What Is An Unsecured Personal Loan? How Does It Work?

If you need to pay for changes to your home, unexpected expenses, or get a new car. An unsecured loan could be the answer! 
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If you need to pay for changes to your home, unexpected expenses, or get a new car. An unsecured loan could be the answer! 

But what is an unsecured loan and how does it work? 

What are the pros and cons and how do you check your eligibility with bad credit?

We’ll answer some of the most common questions about this type of personal loan and explain how you can use them responsibly. 

What is an unsecured loan?

An unsecured loan (often referred to as a personal loan) allows you to borrow a sum of money without using an asset such as your home or car as collateral. 

The amount you can borrow when taking out an unsecured loan can vary, but it's typically between £1,000 to £25,000.

So, how do unsecured loans work?

How do unsecured loans work?

Unsecured loans are usually offered to people with a reasonably good credit score. This is because borrowers with a healthy credit report are considered less risky than those who've had problems borrowing money in the past.

When deciding whether to approve your loan, lenders want reassurance that you'll keep up with your payments and they won't have to chase you for the money you owe.

Secured loans, on the other hand, can be easier to access if you've got a less than perfect credit rating.

This is because the loan will be tied to your property or car. If you were unable to pay back a secured loan, this could lead to the asset in question being repossessed. 

Secured loans are often larger than unsecured loans and offer lower interest rates too.

Lending criteria can vary from one lender to the next, so the amount you can borrow, the duration of the loan, APR and the interest rate you are given will all depend on your own circumstances and the details in your credit report.

There's a lot of variation between APRs and loan terms too. Terms often last anywhere from one to seven years.

What is an unsecured loan ideal for?

An unsecured loan can be used for a number of different purchases including:

  • Debt consolidation loans

  • Home repairs

  • Home renovations

  • Wedding costs

  • Holidays

  • Buying a car

  • Repairing car faults

  • Vet bills

  • Funeral costs

This list is certainly not exhaustive and there are a number of other purchases you could fund with the help of an unsecured personal loan.

What is an unsecured loan unsuitable for?

Most unsecured loans can be used for anything you wish, but that doesn't mean that taking out this type of loan is automatically a good idea.

For example, using an unsecured loan to pay off student debt is unlikely to be a good idea  especially if you live in the UK. 

Unsecured loans usually have much stricter terms and higher interest rates than student loans, meaning you could be risking future financial difficulties for very little reward. 

If you lose your source of income or earn less than the student loan repayment threshold, your payments will be paused until you earn enough. 

This isn’t the case for unsecured loans, which need to be paid back no matter what your income. 

Unsecured personal loans are also unsuitable for investing or starting a business. Instead, a business loan is more appropriate for this purpose.

It's also unwise to take out an unsecured personal loan to pay for stock market investments. 

Investing (or trading) in the stock market carries a substantial amount of risk and while long term investing can be a smart strategy to build wealth, investing money you can't afford to lose can have serious consequences.

What are the pros and cons of unsecured loans?

Let’s take a look at the pros and cons of unsecured vs secured loans and credit cards. 

Pros of unsecured loans

Flexibility

Unsecured loans can be more flexible than secured loans. You can usually choose what period of time you'd like to spread the payments over. 

Most borrowers can choose a term between one and five years. If you were to get a secured loan, however, your term would probably be five years or more.

Unsecured loans are usually less flexible than credit cards.

You won’t have to put up an asset or collateral

While secured loans certainly have their benefits, using your house, car or another valuable asset as a security can be stressful. 

If you fell behind on your repayments, this could have severe consequences. Thankfully, you don't need to worry about your home being repossessed when taking out an unsecured loan. 

You'll still need to pay the money you owe on time and in full, but the consequences of nonpayment won't be quite as severe. To learn more, take a look at our guide: what happens if you can't pay back a personal loan?

Check your eligibility without damaging your score

Many lenders will carry out pre-qualification checks to determine how suitable you are for the loan, without carrying out a full credit check. 

This means you can get a rough idea how likely you are to be approved without leaving a 'hard' footprint on your credit record. If a lender says it's unlikely your application would be successful, you can try somewhere else. 

If a lender says your prospects are good, you can go ahead with the full credit check and official application.

Apply online

Many lenders will let you apply online and receive the results online too. Online lenders tend to make their decision fairly quickly, so you could have your loan within a matter of days. 

Since unsecured loans don't require collateral, you don't need to go through the process of proving the value or ownership of your assets.

Cons of unsecured loans

Can be expensive

Borrowing money doesn't have to be expensive. In fact, it's possible to use credit cards, personal loans, and even mortgages to your advantage. 

Unfortunately, unsecured loans can be more expensive than other types of borrowing.

Difficult to access with a low credit score

Your credit score is important no matter what type of debt you're looking to take on, but some types of debt require a higher score than others. 

If you have a low credit score, you may struggle to access an unsecured loan.

You may struggle to access a large enough loan

You can usually borrow more money when taking out a secured loan than you can with an unsecured loan. So if you're looking to make a very large purchase, you may have to look at alternative options.

How do I check my eligibility with bad credit?

If you have a bad credit score due to problems with debt in the past or a nonexistent credit score due to a lack of borrower history, you may find it harder to get an unsecured loan with good terms and an affordable interest rate.

One failed application could harm your credit score even further, making it even more difficult to get future applications approved. 

For this reason, it's a good idea to check your eligibility online before making an application.

Price comparison tools will often let you check your eligibility with a number of lenders without carrying out any hard credit searches or leaving a mark on your credit file.

If you apply for an unsecured loan and you're rejected, avoid making any further applications for 6 months. 

This should give you some time to improve your credit history and avoid giving off the impression that you're desperately applying for several loans at once.

Should I use an unsecured loan?

If you're trying to decide between unsecured vs secured loans, here are some questions to ask yourself:

What interest rates will you be offered?

Keep costs down by looking for the lowest interest rates possible. By comparing a few different unsecured loans before making an application, you can reduce the overall cost of borrowing.

How much can I afford?

Some people apply for a loan expecting to receive a set amount, only for the lender to offer a larger loan than they anticipated. If this happens to you, avoid taking on more debt than you can handle.

If you're worried that loan repayments will affect your ability to meet other financial responsibilities, request a smaller amount.

Reducing the amount you borrow and/or increasing the term of the loan are just a couple of ways to keep your repayments as manageable as possible. 

But remember: the longer the term, the more interest you'll pay overall.

How likely am I to default on this loan?

Remember that a loan isn't free money and you'll need to pay it back eventually. Not only can failure to pay it back on time result in charges, it can damage your credit rating and harm your chances of borrowing money again in future.

Unsecured vs secured loans: Key takeaways

Who wins the battle between unsecured vs secured loans? Let's take a look at some of the key takeaways:

An unsecured loan may work for you if...

  •  You only want to borrow a small amount of money

  •  You have a good credit rating

  •  You're not a homeowner

  •  You can afford the repayments

A secured loan may be more suitable if...

  •  Your credit score isn't good enough for an unsecured loan

  •  You need to borrow a large amount of money

  •  You're extremely confident you can make repayments on time and in full