The difference between personal loans and other types of loans is that personal loans are granted without collateral and therefore involve great financial risk for the lending institution. Hence, not all banks grant them in the United States. On the other hand, banks that grant such loans do so under strict compliance with a series of requirements, such as those set forth by Bank of America.
Unsecured loans comprise of three types:
a) Personal loans, those given to individuals for their own use and purpose.
b) Unsecured loans, which are granted to businesses, corporations, and other business entities responsible for repaying the debt.
c) Unsecured loan with guarantor granted to a business. Here the company is responsible for the repayment of the loan, but in case the company does not pay the debt, the guarantor is responsible.
Under what perspective should personal lending be considered in United States?
The granting of these loans involves opposite scenarios for the bank and for the beneficiary.
For the financial institution, this means that it does not have a guarantee or element of value available for attachment in the event of insolvency in payment by the debtor; whereas for the debtor it means a business where it has very little to lose. Hence, unsecured loans could be thought of as a bad or risky investment for banks; however, they offer certain advantages because not all loans are the same.
First, there is the case of an unsecured loan where it is necessary for the borrower to make all the payment payments as an individual individual, but there are also those types of loans called unsecured business loans where the borrower is not a natural person but a company, and finally there is an unsecured loan with personal guarantee, in which there is a guarantee, not by the borrower who in this case is a company, but by a person who assumes the status of guarantor to repay the loan in full.
Benefits & risks of personal lending to financial institutions
Of course, these personal loans offer extensive benefits to the borrower and a great deal of risk for the lender, so the latter grants loan on the condition that the borrower meets a number of requirements, making them practically a kind of reward for customer loyalty.
One of the fundamental requirements imposed by banks such as Bank of America to grant access to these loans is the credit score by the borrower. Because this kind of indicator provides an idea of the borrower’s ability to repay.
In addition, by assuming greater risk with this type of lending, financial institutions tend to set a higher interest rate, just as they set a lower credit line limit.
Similarly, the restrictions or penalties on these loans are more susceptible than other loans, increasing the possibility of loan denial.
On the other hand, certain banks in USA impose fines and penalties on those who try to consolidate their debts with a personal loan.
Because these types of loans are riskier for any lending institution, they carry a higher interest rate and have lower credit line limits than other secured loans. Also, bank cannot offer you debt consolidation loans if they think you are likely to get into debt trouble.
What purpose such loans can be used for?
The use of unsecured personal loans varies, because they can be used to consolidate other debts, such as credit cards and other high-interest debts, by combining these debts into one more manageable and lower-interest loan, and can also be used to pay for education or health care expenses.
These unsecured loans contain higher risks for the financial institution because there is no collateral to back up the debt in case the loan is in default. As a result, they may be more difficult to obtain, carry a higher interest rate, and have lower limits, usually as low as US$5,000.