The top priority for a lender is to make sure their loan is paid back. There are several ways to encourage a borrower to pay back funds they have borrowed. One of the most common and useful is called collateral.

A loan with security, or one that is securitized by collateral is called a secured loan. It is a loan that can be automatically paid back by seizing the collateral. Almost all mortgages are secured by the houses purchased with the borrowed funds.

A loan without security, in which a borrower only pledges repayment with their word, is the opposite, or an unsecured loan.

Collateral

When a borrower takes out a loan, one of the ways they can demonstrate financial responsibility and persuade a lender they will be able to make their payments is to pledge property or security equal to or greater than the value of the money borrowed. Although there are personal loans for bad credit that don’t require a credit check.

The best example is a mortgage. Borrowed funds are used to buy a house. The borrower makes payments against the borrowed funds, and the lender accepts title to the house itself as collateral for repayment of the loan. If the mortgage is not paid, the lender seizes the house to cover the value of the borrowed funds.

It is often much easier to take out a personal loan if funds can be secured with some kind of valuable property, such as a certificate of deposit, jewelry or securities like stocks or bonds.

Signature

Personal loans are very often taken out on a borrower’s signature alone. Most revolving credit accounts fall into this category of personal loans. A credit card customer opens an account and makes purchases up to the limit of their credit line. These funds are not secured by collateral. They are simply pledged to be repaid on the word of the borrower.

It is for this reason most credit cards have very low limits. This reduces the risk faced by the lender. Because they have no collateral and no “secured” option if the borrower does not pay, the only way they can limit their risk is to reduce the amount available to borrow. If the loan goes bad, they face only a small loss.

Qualifying

Getting an unsecured personal loan is often more a question of relationship than it is financial calculus. Banks and financial institutions are interested in a borrower’s credit, but very often a long-standing customer will have more credibility when it comes to taking out an unsecured loan than someone the bank’s management doesn’t know very well.

Most of the time it doesn’t hurt to simply ask. The worst a lender can do is say “no.” Often times they will explain their reasoning, which will give you a roadmap for how to get approved next time.

Borrowing and understanding loans is a skill, like anything else. The more experience and knowledge you have to apply for a personal loan, the easier it gets.