It’s true. Unsecured loans traditionally come with higher interest rates than secured loans. This doesn’t mean, however, that there aren’t good deals on unsecured loans to be found.
Secured vs. Unsecured Loans
Secured loans have better rates because they are backed by collateral. This is some form of personal property such as a car or a home that, in the event you default, can be repossessed. The bank doesn’t have to take such a risk on lending out secured loans, so they’re more likely to offer better interest rates.
Unsecured loans are considered greater risks because there is no collateral tied to them. A personal loan is a good example of this. If you take out a $10,000 line of credit, the lender has to trust that you will pay that money back and not default. If you do default, they lose the $10,000. For this reason, they charge higher interest rates as a safety net for the lender. The more money they earn in charging you interest, the less risky the loan.
The length of the loan can also determine the interest rate. Personal loans that have a longer duration are considered higher risk. The lender has no way of knowing whether or not the borrower will be in a position to make regular payments two or three years down the road, so they charge higher interest rates than they would on a short-term loan. This also compensates the lender for any risks associated with inflation.
None of this means that you cannot find an unsecured loan at a reasonable interest rate. In fact, personal loans often come with much better interest rates than credit cards. Taking out an unsecured loan is a much better option than opening a new credit card when considering the interest rates alone.
Improving your credit score can even help in getting you a better interest rate because you appear to be much less of a risk to the lender. The lower your score, the higher your interest rate will be or, in many cases, your loan application may be rejected. If this is the case, you will need to work on cleaning up your credit history in order to even qualify for an unsecured loan, let alone get a good interest rate.
Because personal loans depend greatly on the borrower’s credit history, borrowers with great credit scores will be able to get the best deals and end up paying back less interest in the long run. Other low-risk borrowers include those that own property, have stable employment and have a history of paying off unsecured debt. The best thing to do, no matter what your credit score is, is comparison shop various lenders to see which one offers the best interest rates.