What is an unsecured loan?

An unsecured loan is best defined as a loan that is not backed by any collateral. This means that there is no specific asset that the lender can claim if the borrower fails to repay the loan. Instead, the borrower's promise to repay, along with their creditworthiness, serves as the primary basis for the loan approval and terms.

This type of loan typically carries a higher interest rate than secured loans, which are backed by collateral, because the lender faces a greater risk of losing money if the borrower defaults. Examples of unsecured loans include personal loans, credit card debts, and student loans, where the lender relies on the borrower's credit history and ability to make payments rather than taking possession of a tangible asset.

In contrast, other options highlight different types of loans. A loan backed by collateral indicates a secured loan, which is not applicable here. A loan for a specific purchase may refer to personal or auto loans that typically require specific usage, while a government-backed loan usually pertains to loans supported by government entities, such as FHA or VA loans. These definitions clarify the boundaries of what an unsecured loan constitutes, underlining why the correct choice aligns closely with the fundamental characteristics of unsecured lending.