Secured vs. Unsecured Loans: What's The Difference
Secured vs
Secured vs. Unsecured Loans: What's The DifferenceLoans can come in many different shapes and sizes. They can also be a very big financial commitment. By applying for a loan and taking the funding, you will be agreeing to apply a portion of your income toward paying off the loan, every month. Failing to do so could result in a wide variety of consequences, such as default, a major blow to your credit score, and even repossession.
While loan sizes and terms can vary widely, there are really only two main types of loans: secured and unsecured.
Let's begin by taking a look at secured loans. A secured loan simply means that it is "secured" against something you own, such an asset. This means that you must place an asset up for collateral (a house, a car, property, etc.), and failing to repay the loan or adhere to loan terms could result in repossession of that collateral. The lender would then sell the asset in an attempt to recover their losses.
There are a few distinct advantages associated with a secured loan. One advantage is that it is usually possible to borrow a higher amount of money with secured loan, as opposed to an unsecured loan. It is also possible to obtain more flexible payment terms that can be spread out over a longer period of time. Because lenders know that they have your collateral waiting in the wings, they are often less worried about getting their money back, and are willing to work with you a bit more. It is for the very same reason that interest rates are usually lower as well. Another advantage of a secured loan is, even if you have a bad credit history, you still may be able to obtain this type of loan. By providing an asset, you are reassuring your lenders that you have good intentions and they will be repaid the entire amount of the loan. That being said, if you already have significant debt, taking out another debt (in this case the loan) may be a bad idea that pushes you over the edge.
Now let's look into unsecured loans. Unsecured loans do not require you to place any assets up as a form of collateral. The lender puts a contractual obligation in place at the time the loan is issued, and relies solely upon this agreement for repayment. Because there is significantly greater risk to the lender, the amount that you can borrow is usually much less than a secured loan, and payment terms are generally much stricter and spread out over a shorter period of time. For the same reasons, lending criteria are also much more stringent. This means you will be charged a higher interest rate, which will be further determined by your income level and previous credit history.
Just as with secured loans, there are a few distinct advantages of unsecured loans. One such advantage is that they do not tap into the equity of your home, property, or other assets, so you eliminate the risk of repossession. Lenders cannot take claim to any of your belongings, even if you completely default on the loan. That being said, they can pursue legal action against you, and turn your account over to collection. Unsecured loans are also cheaper for smaller purchases than charging the amount to a store account or credit card. Store accounts and credit cards apply very high interest rates, sometimes from the time of purchase, which are compounded monthly and can really add up. If you are planning on repaying the loan over the course of just a few months you can save a great deal of money by taking out an unsecured loan to help pay for your purchase.