6 Things About Unsecured Loans You Must Understand Before Using One

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Unsecured Loans What Are They and When Do You Use What

You need some money urgently and you can’t ask your friends or family. So the next option is, of course, to go for an unsecured loan. If you are thinking about getting an unsecured loan, then you must understand the various benefits and pitfalls associated with them before you opt for one. You do not want to get yourself into a debt trap just because you are not required to submit any collateral.

Broadly, loans that you get from banks in Singapore are divided into two main categories: secured and unsecured. Credit cards and personal loans are the two major types of unsecured loans. Home loans and car loans are examples of secured loans.

If you get an unsecured loan, you are not obliged to submit any collateral. The amount is lent to you based solely on your ability to repay. The catch here is that the loan will carry a much higher rate of interest as the lender has no principal asset securing the loan.

Because of this lack of collateral, you will also not lose anything if you default on your monthly instalment. However, you may have to face constant reminders and confrontations with the bank!

Nevertheless, you must always make good on your debt as the consequences of defaulting on your debts are quite severe. Defaulting on your debts will not only ruin your credit score drastically, but will also prevent you from getting any other loans in the future.

Related: 3 Aspects of Personal Loans You Need to Understand Before Getting One

When should you apply for personal loans?

You must carefully consider your position first, before getting a personal loan. While you can get personal loans for any purpose, it is always better to take it when you get a long-term or immediate economic benefit. Some of the situations include paying off debt, home improvement, and education.

You should always avoid taking a personal loan when you are not getting any economic benefit. When purchasing a car or buying an expensive watch, for example.

Let us now take a look at the various characteristics of unsecured loans:

1. Credit score

Before applying for an unsecured loan you must always ask yourself if you can afford to pay back the loan along with the steep interest amount. It is also advisable to check your credit report and creditworthiness. Banks will check your credit history to decide whether you are worthy of getting an unsecured loan.

The score can also determine the rate of interest the bank offers you. Banks will look into a combination of factors before considering your interest rate and application for an unsecured loan. These include your previous credit cards, mortgages and other loan liabilities.

Banks mostly use risk-based pricing when charging interest rates. This means that the lower your score, the higher the probability of you defaulting on the loan. So if lenders see you as a risky customer, they will charge higher interest rates.

2. Effective Interest Rate (EIR)

While assessing your options on unsecured loans, use the Effective Interest Rate at all times as the basis of your comparison. Some banks or lenders may avoid informing people about EIR as it reveals the real cost of borrowing.

If you are clear about the stated terms of the unsecured loan, you can easily calculate the EIR. The EIR will take into account the compounded interest over the borrowed period, including the processing fees and other charges.

3. Types of unsecured loans

  • Line of Credit

With the help of a personal line of credit, you will be able to access a large pool of funds in case of an emergency. Just like with credit cards, you will have a limit with a line of credit and there is also an annual fee. Like personal loans, you will get the money deposited into your preferred bank account, or through a cheque.

  • Debt Consolidation

If you want to consolidate all your unsecured loans across different financial institutions to one loan, then you can opt for a Debt Consolidation Plan or DCP. DCP is a form of debt refinancing programme to help you manage your debts, typically as a last resort. However, some unsecured loans such as education and medical loans are not included in a DCP.

  • Personal Loan

This is a general-purpose loan that borrowers most commonly use to clear their current debt or to make a big one-time investment such as paying for their wedding.

  • Credit Cards

We all know what credit cards are – A payment card issued to you to allow you to pay for goods and services, based on the cardholder’s agreement to pay back the amount due within a fixed time frame.

4. Types of interest rate packages available with unsecured loans

  • Variable Interest Rate

If you choose an unsecured loan that charges a variable interest rate, the interest amount that you will have to pay will vary throughout the period of the loan. With variable interest rate, you can make additional repayments that will help you clear your debt early.

However, it is riskier as well. You may end up paying double or triple the interest amount from the time that you applied for the loan.

  • Fixed Interest Rate

If you want an unsecured loan wherein the repayment amount remains fixed for the whole loan period, then you must opt for a fixed-rate package. This will help you in preparing a proper budget plan and managing your finances better.

5. Early repayment terms

Although paying back an unsecured loan early may seem like a great idea, you may have to pay many charges associated with early repayment. An early repayment charge is more or less equal to one or two month’s interest. You will be charged even more if you repay much earlier in the term. For example, DBS charges S$150 if you want to pay off your unsecured loan or credit line before the tenure ends.

You must be aware of the charges linked to paying off the balance amount before the end of the term.

6. Unsecured loans from non-banking financial institutions (NBFC)

Getting an unsecured loan from a non-banking financial institution is much easier as they do not have strict rules. Most NBFCs have a simpler approval process, thus making the entire process of disbursement of loan faster. But the interest rates are likely to be higher than what qualifying full banks offer.

None of us knows what the future holds for us. We might need a loan or we may not. However, it is necessary to understand all the aspects of an unsecured loan if we ever need to go for one.

Read this next: 4 Important Things You Need to Do When Getting Personal Loans

 

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