At first glance it would appear that any lender that approves an unsecured personal loan to someone with bad credit is taking an unnecessary risk. If the person with bad credit supplies some collateral to the loan, it does not seem as risky. After all, if the person defaults the collateral is passed to the lender to repay the loan.
But this appearance of high risk when it comes to unsecured personal loans, also known as signature loans, is not as real as it would appear. It is true that the exact same loan, including principal, interest and term length, made to two people with the same bad credit rating would be more risky for the person who does not supply collateral as compared to the person who does supply it.
But that is why a lender would not offer the same terms to both people. The lender will make a profit providing a loan to each of the people. It is just that the person without security will have different loan provisions.
Collateral Does Make a Difference
Risk is all about perception. The risk is perceived to be higher for the person without collateral than for the person with collateral. Collateral lessens the risk because it guarantees repayment.
But most people with bad credit do not have any collateral to offer. Common forms of collateral include family jewelry, cars and home equity, but anything used must match the loan amount. If you wish to supply collateral for a $10,000 loan, you need a $10,000 asset.
This is why approval for unsecured personal loans involves higher interest rates and often strict penalties for missed payments. This also places a limit of about $25,000 for the largest unsecured personal loan available.
If Collateral is So Good, Why Offer Unsecured Loans?
Why would lenders ever accept the additional risks of unsecured loans? A couple of things come into play here. First of all, the lender will approve an unsecured personal loan with provisions that make it more profitable for them due to the higher risk on not getting repaid. Additionally, most of the people who suffer from bad credit want to improve their credit rating. This supplies the borrower with an extra incentive to make timely payments. When this psychology of borrowers is introduced into the loan equation, it turns out that the risk of default is not as large after all.
Affordability is the biggest obstacle when it comes to a large unsecured personal loan. Lenders are not stupid; they know that if they can find ways to make the loan affordable, that people with bad credit will do business with them. Lower monthly payments mean fewer missed payments.
The easiest way to make a loan more affordable is to extend the life of the loan. The longer the repayment period, the smaller the individual payments will be. Lenders make their profit in the interest rate and longer repayment terms mean more interest payments over time.
Options Do Exist
Applicants and lenders operate differently today thanks to the internet. It is easy and fast to find online offers from a variety of lenders. Many times you can find the lenders terms listed. There are comparison sites that will do much of the leg work for you.
In exchange for a slightly higher interest rate, you can get your loan applied for and approved within a few minutes. Be sure that you are not applying for a payday loan when you mean to apply for a longer term loan. Payday loans charge high interest rates and short repayment terms.