Secured vs. Unsecured Loans

Secured and Unsecured Loans – What’s the Difference?

Secured and Unsecured Loans - What’s the Difference?
 

Though it is never desirable, there may come a time that you will need to consider securing an alternative source of fund to satisfy an immediate need, such as a family emergency, additional fund to buy a home, a car, or to start a new business.

In securing a good source of financial support, you may consider a number of options. A quick and easy source of fund would definitely be close relatives and friends who may lend or even add in funds without requiring additional money in return. A second option would be your workplace. Securing a loan from your employer may provide even a greater advantage as this may also guarantee continuing work with the same employer. Then, you have the ever reliable credit card. You won’t need to worry much when considering this option, as you will never need to think of anything else except your credit limit.

However, if you need fund which is more than what these previous options can offer, your next option is to secure the assistance of private companies such as banks and lending companies that offer either a secured or an unsecured loans.

When thinking of the best option, you need to be smart in determining which would best suit your needs as well as your financial capabilities.

Two of the most common types of loan are the secured and the unsecured loans. This article will give you a better understanding of what these types are, as well as the advantages and disadvantages of each of these types of loan.

Understanding Secured Loans

A secured loan requires that you have to use something of value that you own, such as your car, house, or other valuable personal property. Other items such as stocks and bonds can also be used to secure a loan. These are what lending institutions call as collateral. While the loan has not yet been fully paid, the lender holds the title or deed to the collateral or places a lien on it until the loan has been paid in full, including interest and any applicable fees.

Secured loans are extended not just for new purchases. These can also be home equity loans or home equity lines of credit. Such loans are based on the amount of home equity, which refers to the current market value of your home minus the amount still owed. In this case, your home is taken as the collateral.

In essence, a secured loan means you are granting “security” that your loan will be paid back according to the agreed terms and conditions. If you do not settle the loan, the lender has the right to take possession of the collateral, as well as apply the proceeds of the sale of the collateral to the outstanding debt. Putting your home or other property on the line is a reliable guarantee that you will do everything in your capacity to pay off the loan.

Secured loans offer borrowing limits that are usually higher than those offered for unsecured loans because of the guarantee provided by the collateral. Mortgages as well as home equity lines of credit are two usual types of secured loans. Moreover, this type of loan allows either a fixed or variable interest rate that can last for a set or variable amount of time.

As such, with a secured loan, you are granted a longer time to pay back the loan amount. Interest rates are likewise frequently lower as the lender holds your collateral and faces less risk if you don’t pay back the loan. However, the process of getting approval for a secured loan may take longer and may also require more paperwork.

Examples of Secured Loans:

  • Mortgage
  • Home Equity Line of Credit
  • Auto Loan (New and Used)
  • Boat Loan
  • Recreational Vehicle Loan

Unsecured Loans: What’s the difference?

On the other hand, unsecured loans are the opposite of secured loans. These include credit card purchases, education loans, or personal (signature) loans. With this kind of loan, lenders take more of a risk as there is no property or assets that is taken to recover in case of default. This is the reason why the interest rates are considerably higher with unsecured loans.

The lender believes that you can repay the loan on the basis of your financial resources, hence approves the loan. Lenders issue funds in an unsecured loan based solely on the borrower’s creditworthiness as well as your promise to settle the loan. Your loan application will be judged based on the five (5) C’s of credit (borrower’s creditworthiness) — character, capacity, capital, collateral, as well as conditions. Character, capacity, capital, as well as collateral refer to the borrower’s willingness and ability to repay the debt. Conditions, however, include the borrower’s situation as well as other general economic factors.

Before, loans were issued this way with a simple handshake. If a borrower fails to settle the loan, the lender can sue the borrower to collect the amount owed. This can take a great deal of time, and legal fees can add up quickly. Thus, banks would charge a higher interest rate on these so-called signature loans. Moreover, credit score as well as debt-to-income requirements are normally stricter for these types of loans. They are only made available to the most credible borrowers.

Examples of Unsecured Loans:

  • Credit Cards
  • Personal (Signature) Loans
  • Personal Lines of Credit
  • Student Loans (note that tax returns can be garnished to repay delinquent student loans)
  • Home improvement loans

 

There are times that others opt for secured loans as their credit history will not allow them to get approved for an unsecured loan. Even though you may qualify for a larger loan with a secured loan, you still must be careful to choose a loan that you can afford. As such, you need to make sure to pay attention to the interest rate, repayment period, as well as the monthly payment amount.

Considering all these, here are some quick tips you might need to think through when deciding what type of loan you will apply for:

  1. Approach the lending company to see what they offer. Some will offer special deals to borrowers who have a good record repaying their mortgage/s and or loans.
  2. Check for websites to see if you can get a better deal from another lender. Be sure to compare the terms and conditions, as well as fees of each loan and what could happen if you are unable to settle the loan.
  3. Note whether credit history will show up on your credit file. Some lenders will carry out a full credit check on you if you get a quote for a loan. This would make it seem that you’ve actually applied for the loan. This could harm your credit rating, if this will happen frequently.