Personal Finance

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Unsecured loans: Understanding Its Types and Benefits

Published On Feb/25/2024

During the course of life, you incur several expenses. While some may be planned purchases, at times, an unexpected expense may crop up without any warning. Whether it is planning a destination wedding, going on a vacation, renovating your home or paying medical bills, you need access to funds.

One of the best alternatives to get the amount without disturbing your savings or investments is to apply for an unsecured loan. If you are unsure of unsecured loan meaning, read on to know more.

What is an unsecured loan?

As the name suggests, an unsecured loan is a form of credit that does not require you to provide any form of security or collateral to the lender against the amount you borrow. Unsecured loans are generally approved based on your credit score, repayment history and financial profile. So, to get any form of unsecured loan, be it a personal loan or a business loan, maintain a high credit score of 750+.

Also, unsecured loans typically have a simple eligibility and application process as the lenders do not do a property inspection, which increases the approval time. But, unlike secured loans, where the collateral acts as a security for the lender, in unsecured loans, the lenders take a higher risk. So, to mitigate the risk, they offer unsecured loans at higher interest rates.

Types of unsecured loans

Over the past decade or so, higher disposable income in the hands of the young generation has led to a significant surge in the demand for unsecured loans. The variety of loans available is also a critical reason for the rising demand. For example, you can avail of an unsecured loan for a wide range of purposes, from education to business and buying a luxury product.

In India, unsecured loans are broadly classified into three types:

  • Term Loan

As the name suggests, a term loan comes with a fixed repayment term or tenure. You must repay the amount within the specified period. You can pay the amount in smaller instalments known as EMIs (Equated Monthly Instalments) throughout the loan term.

Generally, most lenders offer term loans at fixed interest rates, which are decided at the time of application. The EMI you pay includes both the principal amount and the interest component. Apply for a term loan is a great way to get a lump sum amount for purchased fixed assets.

Consolidation loan

Today, the easy availability of loans for different purposes can lead to the accumulation of a large debt and increase the risk of default. If you have acquired multiple loans, you may find it hard to keep up with the payments, and the rising interest will only increase your financial burden.

During such times of financial hardship, a consolidation loan can greatly help. With this loan, all your accumulated debts culminate into one single debt, allowing you to repay the amount with a single EMI and reduce your burden considerably.

Revolving Loan

A revolving loan is a unique financial instrument that allows you to borrow an amount, repay it, and borrow again. In a revolving loan, you are assigned a specific credit limit, and you can borrow as many times as you want until you reach the maximum credit limit.

You can use the credit multiple times during the tenure as and when the need arises. Also, you can choose the entire credit limit in one day or in parts. But once you repay the dues, your credit limit is restored, and you can borrow multiple times.

Let us understand the working of a revolving loan with an example.

Miss. Richa Sinha takes a revolving loan of Rs. 1 lakh for one year. In the one-year tenure, her outstanding amount cannot be more than Rs. 1 lakh. She withdraws Rs. 60,000 in a day and repays the amount within 30 days. Now, her credit limit will be restored to Rs. 1 lakh, and she can use the amount anytime.

At the end of the loan term, you must repay the borrowed amount along with the applied interest. It is an excellent form of credit that you can use during an emergency or to get over a temporary cash crunch situation.

Benefits of Unsecured Loan

Unsecured loan comes with a range of attractive benefits, making it the go to option for getting access to funds.

Quick Application Process

Unlike secured loans, the application process for unsecured loans does not involve complex documentation. If you have a few basic KYC (know your customer) documents handy and a good credit score, your loan will be processed quickly, and you can get instant disbursal.

No need for collateral

One of the most significant benefits of an unsecured loan is that you do not have to pledge any of your assets to the lender.

Flexibility in usage

Unlike secured loans like home loans that can be used for only a specific purpose, in unsecured loans, you have the flexibility to use it for any purpose you want. You can use it for buying a fixed asset, increasing your business working capital, going on a dream vacation, paying child’s education fee or planning a destination wedding.

Final Word

Taking a loan is a big financial decision and you must have a complete understanding of the type of loan you avail. Hope this blog has helped you understand the different aspects of an unsecured loan. So, maintain a good credit score and keep the documents handy beforehand to avoid last-minute hassles and delays in the approval process.