With all the options the loan market has to offer, it is very easy to get overwhelmed. First-time borrowers tend to lack the knowledge on loan basics, making it hard to navigate in all of that uncharted territory.
The very first thing a borrower should be aware of is the very notable difference between secured and unsecured loans. Why is this important? Well, because every single loan falls under either one of these categories, so this knowledge should be considered the very foundation of your path to loaning. (Secured vs Unsecured Loans)
What are Secured Loans?
These are often referred to as homeowner’s loans because a borrower’s property is traded in for its monetary value. If a borrower is unable to repay the loan, a lender is within their right to claim possession of the property or its parts. More generally, however, secured loans can use any kind of collateral to secure funding.
Secure Loans Collateral
While homes are the most common collateral used in a secured loan agreement, other types of collateral can apply. Here is a list, in no particular order:
- Life insurance
- Valuables and precious collectibles
- Bank accounts
- Motorcycles, cars, boats, bikes and other vehicles
- Bond investments
Lenders are more likely to offer better rates and larger sums on secure loans on the assumption of reclaiming the full value of the loan out of the borrower’s property. Thus, the more specific terms of the loan (amount, duration, interest rates etc.) will be personalized depending on the free equity held in a borrower’s property.
Credit Score Leniency: Your collateral vouches for you in a way that makes a low credit score less of a factor in a lender’s mind.
Longer Repayment Periods: The reason many lean towards secured loans is their repayment duration tends to last longer than its alternative (unsecured loans). Some home loans may allow repayment over 30 years, as lenders rely on real estate to grow in value and add to the collateral.
Larger Amounts: Secured loans are the way to go if you’re looking to borrow a significant amount of money.
Lower Interest: If you’re on a tight budget, you might want to take out a secured loan as those come with lower interest rates when compared to their unsecured counterparts.
Losing your Property or Assets: Keeping track of repayment is a must when it comes to secured loans, as it might cost you the collateral you put up for it.
What are Unsecured Loans?
Unsecured loans, on the other hand, do not involve any collateral during the borrowing or repayment process. These, though more moderate in their amounts, are the more common of the two loans.
The approval process of an unsecured loan depends more on your creditworthiness, as a lender will likely check your reports before deeming you worthy. This practice proves more risky for lenders given the lack of material reassurance. Therefore, a high credit score becomes the driving factor in a lender’s decision-making.
No Risk of Collateral Loss: With unsecured loans, the absence of the property loss risk can counteract the initial reservation towards higher interest rates.
Flexible Amounts: Unsecured loans are better for smaller-scale financial hurdles while the alternative (secured loans) are reserved for substantial borrowing.
Damage to Credit: Failing to repay an unsecured loan may not take away your property, but it can harm your credit. Keeping up with your regular payments is key when your credit score may risk a credit-dependent borrowing procedure.
Higher Rates: With no back up collateral, unsecured loans usually charge higher rates than their counterparts. This might be something to consider if you’re planning on short-term borrowing.
When it comes to choosing between secured and unsecured loans, the best option truly depends on your circumstances. A better choice will always save you more money over the other.