LENDING – UNSECURED LOANS Copy

Banks and other lenders categorise loans as either secured or unsecured. A secured loan is backed by an underlying security or collateral, such as a house. An unsecured loan, sometimes known as a personal loan, does not require security.

An unsecured loan is provided without security or collateral, and will usually be much smaller than a mortgage. This can also be known as a personal loan, which might be used to buy equipment or for a holiday. Many banks now offer online calculators so borrowers can estimate the costs of a loan over several months or years. As personal loans are not backed by security, banks tend to charge higher interest rates to reflect the higher risk of the loan.

To calculate the amount of an unsecured loan that the borrower can afford, a lender can analyse the income and spending of the customer through their banking records, and calculate the amount that a borrower can afford to repay each month. Lenders can gather additional information about a borrower through a credit bureau or credit registry, which keeps independent records of borrowers. Credit registries are generally publicly-operated companies, run by the central bank. Credit bureau are generally privately-operated companies and tend to gather more detailed data than credit registries. Credit bureau assign scores to individual borrowers which lenders can use to assess the riskiness of a loan.

Not all countries have credit bureau, which tend to be a feature of developed markets. In some cases, lenders also rely on what is called ‘Alternative credit scoring’, which relies on non-traditional metrics and may include mobile phone data and social media data.

There are several types of unsecured loan. The most popular is the credit card, which is unsecured, revolving credit.

In the language of payments, credit cards are typically issued by banks or credit unions. A credit card account is separate from a regular current account. It comes with its own line of credit, and a cardholder can use this line of credit each month. Most issuers charge an annual fee for use of a credit card. If a cardholder pays off the total amount on the card within a thirty-day period, the issuer does not charge interest. However, a cardholder can choose to pay off just a certain amount owed on the card each month, and to pay interest on the outstanding amount. The issuer will typically set a minimum amount that the cardholder must pay off an outstanding balance each month, and may charge a fee if no minimum payment is made. Credit cards are typically one of the most profitable bank offerings. Consumers can use credit cards to pay down a balance over a very long period of several years.

Instalment loans, on the other hand, have fixed repayment periods. This is also typically an unsecured loan where repayments are fixed over a certain period of months or years. The lender calculates the principal amount borrowed plus the interest to be paid over the course of the loan, and the total amount is divided into equal portions. Consumers use instalment loans for white goods such as refrigerators or televisions, to pay for holidays, and to pay for electronics and clothing.