How Does an Uncollateralized Loan Work?

Loans made without collateral typically charge higher interest rates than collateralized loans.

Loans made without collateral typically charge higher interest rates than collateralized loans.

People with excellent credit ratings frequently have the option to receive loans without putting up any financial backing or collateral. Lending done without collateral is also known as personal, signature or unsecured lending. Banks and credit unions typically make uncollateralized loans to account holders or members who have a long association with the institution. Depositors with large amounts of cash in investment accounts (including retirement and savings) and a record of sound money management typically receive signature loans.

Collateral

Cash deposits show evidence that the borrower has the ability to manage money; however, cash accounts offer little assurance for lenders. A borrower can empty a bank account filled with cash in just minutes. Collateral backing offers the bank physical backing to support a loan application. Lenders typically request collateral, including real estate equity, insurance bonds, ownership of stocks or bonds, or other real property, such as a boat, motorhome or gold coins, to lend money.

Lending Practices

Applying for an uncollateralized loan requires filling out an application listing checking and savings accounts, all sources of income and all outstanding debts. Applications ask for information about credit and charge cards, mortgages, and auto and student loans. The application requests a list of any other signature loans held by the applicant. The information must list detailed information, including the exact amount due on any debt and charge cards. The potential lender looks for key information about the applicant showing the borrower has good credit habits. Lenders require employment information and information about the potential borrower's spending habits.

Uncollateralized Lending

The lender focuses on the creditworthiness of the borrower in making an uncollateralized loan. After the initial application, the lender investigates the potential borrower by examining credit reports and bank accounts. Lenders also confirm employment, monthly take-home pay, and income from other sources, including any pensions or income from court settlements. If the risk is acceptable and the credit report clear, the lender has the borrower sign an agreement for the uncollateralized loan. The agreement lists the loan amount, payment schedule, and penalties if the borrower fails to meet the terms of the loan agreement.

Uncollateralized Defaults

Lenders file lawsuits to collect borrowed money when signature loan borrowers default on lending agreements. The lender can continue to charge interest on the unpaid loan amount during the legal action. When the borrower fails to make payments on an uncollateralized loan, the lender reports the default to credit agencies and begins the process of collecting from the borrower. Depending on the amount of the loan, this might include filing legal paperwork. The lender has the option of selling the loan to a collection agency. The secondary company then takes over the efforts to collect the loan from the borrower.

About the Author

Lee Grayson has worked as a freelance writer since 2000. Her articles have appeared in publications for Oxford and Harvard University presses and research publishers, including Facts On File and ABC-CLIO. Grayson holds certificates from the University of California campuses at Irvine and San Diego.

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