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How does an Unsecured Personal Loan work?
Unsecured personal loans can be used for a range of purposes including purchasing assets for personal use.
The main feature of an unsecured loan is that you don’t have to provide any collateral as security to the lender (bank or finance company). This means that the lender does not have any rights to repossess an asset that you may purchase using the loan. As a result lenders regard unsecured loans to be higher risk to them and the interest rates charged are generally higher than they are for secured loans.
Who does an Unsecured Personal Loan suit?
Unsecured loans are commonly used by private individuals for personal use purchases.
Before you buy a second-hand asset you can check to see if the owner has ‘clear title’ or if there is a registered interest in it by doing a PPSR (Personal Property Securities Register) check to protect yourself against potential repossession.
The Personal Property Securities Register is the register where details of security interests in personal property can be registered and searched. The Australian Financial Security Authority (AFSA) is the Australian Government agency responsible for administering the PPSR. You can visit their website at www.ppsr.gov.au .
For used cars you can also arrange checks through other service providers to see whether the asset has ever been an insurance write-off or stolen and if the vehicle has suffered from flood or water damage.
The Key Factors
Finding the best unsecured personal loan for you will depend on your individual circumstances but the main factors to consider are:
Interest Rate – The rate of interest plays a large part in determining your repayment amount. The higher the interest rate the higher the repayment amount. But you need to be aware that the interest rate isn’t the only factor that will effect the total cost of your loan.
Fixed and Variable Rates – The interest rate is usually fixed, meaning that it will remain the same for the life of the loan, but it can also be variable. If the interest rate is variable this means that it can change during the time that you have the loan. Variable rates can be linked to the rate of interest that the lender is paying for its money in the same way that a lot of home loans are. So generally speaking if you have a variable rate and the Reserve Bank increases interest rates your interest rate and repayment amount will increase. If the interest rate is fixed you know exactly how much your repayments are going to be for as long as you have the loan and you can budget around them accordingly.
Comparison Rate – The comparison rate combines the interest rate with any foreseeable fees and charges involved with your loan to help you to identify the actual cost of the loan. However, it doesn’t include government and statutory fees, any insurance premiums or any fees that could possibly occur during the term of the loan such as statement fees or late payment fees for example.
Fees – There are various fees that can be included in your loan. Usual fees include, establishment fees, which are one off amounts charged by the lender (bank, finance company) for accepting and setting up your loan, as well as ongoing fees such as account keeping or loan service fees. The fees are included within your loan repayments so you should not have to pay them from your own funds. Make sure that you are aware of all the fees associated with your loan and make sure that they are included within the repayment amount that you are quoted.
Loan Term – Lenders have minimum and maximum periods for repaying the loan. The minimum loan term is usually 1 year with the maximum usually being 7 years. The term of the loan is another significant factor in determining what your repayment amount will be. The shorter the term the higher the repayment and the longer the term the lower the repayment. But remember the longer the term the more interest you will be charged and the more you will pay back in total.
Deposit – If you are using an unsecured personal loan you can use cash or a trade in to reduce the loan amount. By reducing the loan amount you can reduce your repayments and the total amount payable.
Total Amount Payable – This is the total amount that you pay back to the lender for your loan, including the original amount borrowed, the total amount of interest charged over the full term of the loan and any fees charged.
Additional Repayments and Early Termination – Some lenders provide the option to make additional repayments into your loan. Making extra payments into your loan has the effect of paying your loan off sooner and reducing the amount of interest that you pay and in turn reducing the total amount payable. You need to bear in mind that some lenders will charge fees if you pay the loan off early. If making extra payments and paying off your loan early is important to you then make sure to check that your loan allows you to do this and any costs associated with doing this are acceptable to you.
Minimum and Maximum Loan Amounts – Normally the lowest loan amount available from mainstream lenders is $5,000. The maximum varies from lender to lender but $50,000 is the most that many lenders will provide for an unsecured personal loan.
Flexibility – You can use an unsecured personal for a combination of purposes. The amount that you borrow does not have to be used for just one purpose such as the purchase of an asset.
No Security – You do not have to provide an asset or property as security for the loan. If you use the loan to purchase an asset you can sell the asset at any time and you do not have to pay out the loan.
Lower Value Assets – If the asset has a low initial or potential re-sale value a lender may not be prepared to offer a secured loan. Unsecured personal loans can be useful in helping you to finance the purchase of lower value or older assets.
Inclusions – You can potentially include things like government fees, insurance premiums and accessories as part of your loan, so one repayment covers all of your costs.
Credit History – If you’re new to borrowing an unsecured personal loan can be a great way to get what you want and help establish a credit history for you which can come in useful down the track for things like mortgages.
Minus Equity – If you are trading in an asset which is financed and you owe more on the outstanding loan than the asset is worth you may be able to include this minus equity amount that you borrow for the unsecured personal loan.
Costs – Any type of borrowing is going to cost you money and a secured loan is no different. But don’t forget using your own money comes with its own costs too. Just think of the savings interest that you lose when you withdraw your cash from the bank and use it to buy what you’re looking for. You just need to make sure that you do your research and get the best the loan for you.
Higher Interest Rate – Because the lender does not have an asset to act as security for the loan the lender has increased risk and as a result interest rates on unsecured personal loans are generally higher.
Stricter Lending Criteria – Because the lender has no security to fall back on their criteria to qualify for an unsecured personal loan can be stricter than it is for a secured loan. It may be more difficult for you to get an unsecured personal loan and the lender may not be prepared to lend the full amount that you are looking to borrow.
Residual Value Unavailable – Because an unsecured personal loan is effectively a cash loan there is no option to have a residual value (balloon payment) to reduce the repayments.
Business Use – If you’re using the loan to purchase an asset which is used for predominantly business purposes then an unsecured personal loan is not the most effective option for you.
Things to Consider
Payment Frequency – Most lenders will give you the option of making weekly, fortnightly or monthly repayments. Choose the frequency that will help you to budget best.
Your Current and Future Circumstances – Think about what your requirements are right now but also your plans for the future. For example, if you’re planning to start a family and your household income is going to reduce whilst you have your secured loan, ask yourself if you would still be able to make the repayments. You may need to consider a loan over a longer term to reduce your repayment. If you expect that your income will increase during the time that you’re paying your unsecured personal loan off check at the outset that you have the flexibility to make additional payments.
Rate for Risk – Some lenders use a system whereby they determine the interest rate that they offer to you based on their analysis of your personal profile. This includes your credit history, employment history and residential status, as well as what asset you are buying and if you are using any of your own cash as a deposit. The better they deem your profile to be the lower the rate you will get.
LoanPlace.com.au is here to help you make sense of it all by providing you with information resources and connecting you with experienced professionals who will search their lenders to find the latest deals so that you get 3 Free Quotes to evaluate and compare.