Getting a loan can be a great way to finance a major purchase. A loan may also be a great way to get the funds you need to cover an outstanding debt. The ability to get the financing you need will depend on your credit situation among other factors. One surefire way to get a lower interest rate is to get a secured loan. This is because unsecured loans come with higher interest rates. Why is this?
Unsecured Loans Come With More Risk
The biggest reason why an unsecured loan comes with a higher interest rate is because there is nothing to secure the loan. Your credit score is the only thing determining your ability to pay back the loan. Even the most reliable of borrowers could still run into issues repaying a loan. Therefore, the unsecured loans are going to come with higher interest rates in order to reflect that risk. It is in your best interest to do everything you can to get your credit score as high as possible.
The Bank Loses Everything If You Do Not Pay
Your lender will get nothing if you fail to pay an unsecured loan back. At least the bank can sell off an asset when you secure a loan with collateral. Not having anything to secure the loan with is going to make the bank wary of issuing that loan. The higher interest rate is way to help the bank more money while the borrower is still paying the loan off.
Higher Interest Rates Are a Deterrent
The interest rate that you pay on a loan is something you have to think about before applying for it. Too high of an interest rate can cause your loan to be more expensive than it needs to be. Unsecured loans become less of an attractive option for borrowers when they see how much more that money is going to cost them. It provides a deterrent for those who would take out an unsecured loan because they don't care about the consequences of not repaying it. Higher interest rates also provide an incentive for a borrower to secure the loan with collateral.
This Limits Who Can Apply
Unsecured loans typically require a high credit score in order to get approval for the loan. Borrowers should have a credit score of over 700 to apply. This gives the bank an opportunity to limit these riskier loans to borrowers who are more reliable. It would be irresponsible for a bank to give an unsecured loan to someone who could not repay the loan. Someone who has a shaky financial profile could ultimately go bankrupt as a way to get out of debt.
Many good reasons exist for why a bank charges higher rates for an unsecured loan. Borrowers should expect to pay higher rates for the opportunity to get a loan with fewer strings attached. It is important that the bank has at least one way to protect itself from losing money on a loan.
Sheryl Fabia is an in-house writer for Franklin Debt Relief. She writes articles on various financial matters and has them published across the web.