When you need a quick cash injection, sometimes, an unsecured personal loan can come to the rescue. But before you choose the personal loan for you, it’s important to understand what an unsecured personal loan is, how it works, and what your options are.
What is an unsecured personal loan?
An unsecured personal loan is a personal loan that doesn’t require you to put up an asset as security. This is unlike the other type of personal loan offered - a secured personal loan - which would require collateral.
You could use an unsecured personal loan to treat yourself to a holiday, an expensive hair revamp, or just about anything. They have the benefit of being more flexible than most other types of loans, which are very strict in terms of exactly what you spend your money on.
Secured vs unsecured personal loans
There are two types of personal loans in Australia: secured and unsecured. Let’s briefly run through the differences between these two personal loans for a better understanding of both.
As mentioned, secured loans require an asset as security, while unsecured loans don’t. This is the biggest difference between the two types of loans, and a few things can be noted as a result.
Unsecured personal loans are typically for smaller amounts and have shorter repayment terms. Without an asset attached to the loan, lenders are typically wary of lending big amounts. With a secured personal loan, if you default on the loan, the lender can seize your asset and sell it to make up for their losses.
But this doesn’t mean that you can freely default on an unsecured personal loan without consequence - your credit score would still take a hit, the lender may instigate court proceedings against you and you could be left in a worse financial position. Just like any other financial product, unsecured personal loans can be great if managed responsibly.
Unsecured personal loans are considered more ‘risky' for the lender. You may see this reflected in a higher interest rate charged when compared to secured personal loans.
Pros and cons of unsecured personal loans
To get a better understanding of how unsecured personal loans work and what you can expect, let’s discuss a few notable pros and cons.
Pros of unsecured personal loans
No security needed: As we mentioned, you don’t need to offer up an asset to take out an unsecured personal loan.
Application process can be quicker: With secured loans, the lender will need to take steps to verify your asset for security, meaning you will need to supply supporting documents. For example, if you were offering up your car, you may need registration documents, insurance documents, or even a valuation. But with an unsecured personal loan, this isn’t necessary, so you may find the application and approval process is quicker
Shorter loan repayment terms: Though this could be considered a con, let’s discuss the positives of this. Firstly, you will be out of debt quicker, which is always a bonus. Secondly, paying off a loan quicker could result in less interest charges overall, which could save you money
Cons of unsecured personal loans
Higher interest rate: Since the lender doesn’t have the same security as they do with a secured loan, you will likely be charged a higher interest rate
Fewer lenders: You may also find that due to the heightened ‘riskiness’ of unsecured personal loans, there are fewer lenders and therefore fewer options for you to choose from. This could mean securing a less competitive deal as there are fewer lenders competing for your business
Borrow less: Again, due to the ‘risk’ of unsecured personal loans, you will likely be more limited in how much you can borrow. Lenders that offer high amount unsecured personal loans may be dodgy, so you should do your research before applying. If you need to borrow a big stack of cash, a secured personal loan may be your only viable option
How to compare unsecured personal loans
There are a few notable features of unsecured personal loans that you should compare to ensure you are getting a good deal. You can do this by using a comparison site like Savings.com.au.
You should look at the interest rate advertised, as well as whether this rate is variable or fixed. A fixed rate will mean that said interest rate will remain the same throughout the life of your loan, while a variable rate may go up or down depending on the cash rate/market activity. Shop around to find the most competitive interest rate available.
Not to be ignored is the advertised comparison rate. This encompasses not only the interest rate but also other fees and charges - such as monthly fees or other costs - associated with the loan. The comparison rate will give you an idea of how much you will pay per year in total fees and charges on the loan.
With this comparison rate in mind, look at exactly what fees and charges apply to the loan. If a loan has a ‘low’ interest rate, but a stack of other fees and charges like an upfront application fee, establishment fee, and so on - it may not end up being such a great bargain.
Pay attention to the loan size you want. If you need $10,000 for a home renovation, make sure that is what you’re applying for.
You should also look at the loan term, which is how long you have to pay back your money borrowed. Is it six months? A year? Ensure the loan type and repayment amounts will be manageable for you throughout the whole loan term.
Along these same lines, know what your repayment terms will be. Will you be required to pay weekly, fortnightly, or monthly? How does this align with your pay cycle or any other financial commitments you may have? You should also find out whether there are break fees/penalties involved in making extra repayments or paying off your loan early.