Let us start with the basics about what an unsecured loan is. As you may know, loans come in two basic forms: secured and unsecured. A loan is said to be secured when the borrower provides the lender with some security. Often, the security is a lien on an asset, which means that should the borrower default on the payment, the lender can take legal possession of the security or the commensurate proceeds from the sale of such security. On the other hand, for an unsecured loan, the borrower does not have to provide any form of security and is given the loan in good faith. Undoubtedly, the lender has a lot to lose, should the borrower default on payments.
Unsecured debt includes personal loans, credit card debt, medical bills, utility bills, credit lines, and any other type of credit that was extended without a collateral requirement.
Factors Affecting the Interest Rate
Unsecured loan rates are higher than other loans due to the risks involved. They are a perfect example of 'high risk, high return' investment, from a lender's point of view.
Now, the rates vary from one country to another. The basic pointers which define them are:
- The perceived risk in lending money to a person without security.
- Market dynamics play a huge role. Any lender would want his rates to be competitive vis-à-vis other lenders. This is how the rates are balanced.
People with a higher credit rating can avail of a lower rate of interest, as compared to those with a lower credit rating. Sometimes, these loans are negotiable. This means that the interest rate on a long term loan can be renegotiated at the end of the year, and if the person's credit score improves, he could get a lower interest rate.
The rate for personal and business loans can also differ. Loans given for asset building like the purchase of a home, business expansion, purchase of machinery, or an acquisition of a business will garner lower interest rates, as compared to personal loans. This is assuming that the lender is convinced that the funds will be used productively and the end result will be more valuable.
Rates may differ from one country to another, but on an average, they are between 12-15%. The best rates can even be as low as 10%. So if you have bagged an interest rate of less than 12% for your loan, you ought to consider yourself pretty lucky.