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An unsecured loan refers to a loan which is based solely on the borrower's ability to repay the loan. This differs from secured loans which require the borrower to use an asset as collateral for the loan. This means the lender will be able to use this collateral to recover funds if the borrower defaults on the loan. This gives the lender a great deal of security and as a result the lender is often able to offer lower interest rates on the loan.
A payday loan is one example of an unsecured loan. This type of loan is based solely on the borrower's ability to repay the loan as opposed to his assets. The lender bases the loan amount on the applicant's net monthly income and sets the maximum loan amount to ensure the borrower is able to fully repay the loan on his next payday.