Loans are a convenient way to get extra money when wanting to cover such as buying a car, renovating a house, paying for college, or emergency costs. However, when deciding on borrowing a loan, most clients are facing two options, having a secured or unsecured loan. Many people are not sure what exactly this means and therefore are unable to decide which alternative will be more favorable for their budget and better meet their preferences. Loan Cheetah professionals have dedicated today’s article to explaining the meaning and purpose of secured and unsecured loans, hopefully helping you find the best solution for your financial requirements.
As both types of loans have pros and cons, provided information and facts will be a good starting point in obtaining a suitable loan.
The vital characteristic of secured loans is that this type of loan is backed by certain collateral. For lenders, collateral is the asset that can be taken as payment if the loanee fails to repay the loan.
Secured loans are mostly required for large loanings such as the money for buying cars or houses. For loans with a large amount, lenders prefer secured loans as the insurance for the caded money. From the lenders’ perspective, secured loans entail less risk.
On the other hand, some borrowers opt for secured loans as they withdraw lower interest rates.
The most common models of secured loans:
- Mortgages – these loans consider that the purchased house is used as collateral. This means, that in case the loanee is not able to pay the loan, the house falls under foreclosure, consequently, the borrower will lose the house.
- Secured credit cards – Borrowers with limited credit history can increase their credit score with a secured loan. In this case, the credit card demands a cash deposit as collateral and the amount of the deposit represents the credit limit. This method provides lenders the possibility to charge cash deposited as collateral in case the debtor doesn`t pay its monthly installment.
- Vehicle loans – These loans are arranged for buying cars, boats, motorcycles, trucks, and other vehicles. In these cases, a certain vehicle serves as collateral if the loanee doesn’t pay the debt. Meaning, the vehicle will be repossessed by the lender as a repayment.
The advantages of secured loans for borrowers are:
- A borrower that invests collateral, has a less stringent requirement for getting the requested loan
- Secured loans often provide the loan with more favorable interest rates
- With secured loans, borrowers can have a longer repayment period and higher borrowing limit
Disadvantages of secured loans for borrowers:
- While secured loans are usually safer for lenders, the loanee can lose its collateral in case that they can`t provide payment
- Besides losing the collateral, default on loan payments hurts the loanees’ credit
The growth of Fintech conditioned the increased use of unsecured loans, providing potential loanees the more versatile options for lending. Even though unsecured loans don`t imply any collateral, failing to repay the loan negatively affects loanees’ credit score, and the unpaid loan can be forwarded to a collection agency, depending on loan arrangement and lenders’ terms. Collection agencies then have the job to collect the debt.
The most common types of unsecured loans are:
- Personal loans – These loans are also called “installment loans” and “term loans” due to their monthly payment amounts for the fixed repayment period.
- Revolving loans – This kind of loan allows borrowers to repeatedly use and repay the loan. The most common revolving loans are personal lines of credit and credit card loans.
- Student loans – Student loans are made for financing college as the student usually have little or no credit history and few assets.
The advantages of unsecured loans for borrowers are:
- In case of failure to pay the loan, the lender is not allowed to confiscate the borrower’s assets without the court’s order
- Doesn’t require collateral
Disadvantages of unsecured loans for borrowers:
- Most often unsecured loans have higher interest rates than secured ones
- Defaulting to pay off the loan leads to significant credit damage
- Bad credit can be a serious obstacle to qualifying for a loan
To resume, the major difference between secured and unsecured loans is in the requirements for collateral and the interest rates. Many features affect loan approval.
The choice of taking a secured or unsecured loan can be a matter of borrowers’ preferences and loan terms. However, if you consider taking either kind of loan, you should have a clear plan for how you will pay off the loan.