While some swear by a cash-only lifestyle, the fact is that the majority of us depend on credit to pay for life’s major expenses over time. When you want to buy an expensive item like a house or a car, wish to start or expand a business, remodel a kitchen, or pay for college, you can ask for a loan at your local bank or online.
When weighing your credit options, you need to choose between a secured and an unsecured loan. Secured loans require you to put up something of value as collateral in case you are unable to repay the loan. On the other hand, unsecured loans allow you to borrow the money outright after the lender evaluates your financial situation. There are both disadvantages and advantages of secured and unsecured loans.
What are Secured Loans?
Secured loans use an advantage to ‘protect’ the debt, while unsecured loans are advanced without any insurance or backup. Secured loans are ideal for those who own property and wish to use it to keep borrowing. By demonstrating to a lender that you are willing to put your possessions at risk in order to obtain a loan, you prove that you are sincere and committed to make full repayments. As a result, the cost is lower, and you will be given a lower interest rate than unsecured loans.
When you get a guaranteed loan, the lender places a lien on the item you give as collateral. When you pay off the debt, the lender lifts the lien, and you own your properties. Since your savings will be confiscated, if you don’t pay off your secured debt, they are arguably riskier than unsecured loans. When you take out a revolving loan, you are also paying interest on the loan depending on your creditworthiness as well as penalties in some situations.
What types of properties should be used as collateral for a secured loan? You can keep real estate, bank accounts, vehicles, stocks & mutual funds, or other valuables.
What are Unsecured Loans?
While an unsecured loan does not need collateral, you will also be paying interest and fees. Unsecured loans include student loans, personal loans, and credit cards.
Since there is no insurance, financial firms make unsecured loans dependent mostly on the credit record and records of repaying previous debts. As a result, unsecured loans may (but do not always) have higher interest rates than secured loans.
Major Differences Between Secured and Unsecured Loans
- Bound by Assets– If you do not pay off the loan, the lender will sell the property you pledged (for example, your car or home) to repay what is owed.
- Loan Size– Given the lower risk, secured loans are usually greater in size than other personal loans.
- Lower interest rates– Interest rates are better and the lender’s risk is lower.
- Defaults and non-payments have a lesser impact– While your credit score will suffer and borrowing will become more expensive in the future, you may not risk your car or house. Since nothing is insured against the loan, debt collectors will be unable to repossess anything.
- Interest rates and loan size– Unsecured loans are normally much lower in size considering the risk – $5,000 to $10,000 is a typical range. Interest rates will rise in order to protect lenders from the risk of nonpayment.
Unsecured personal loans are becoming increasingly prevalent. According to the online credit marketplace Lending Tree, there are about 20.2 million personal loan borrowers in the United States. A personal loan can be used for almost any reason, including remodeling the kitchen, paying for a wedding, taking a dream holiday, or paying off credit card debt.