Secured Personal Loans vs Unsecured Personal Loans
Although it may seem subtle, the difference in secured and unsecured personal loans can have a big impact. Whenever you borrow money from banks, credit unions, or individual lenders, you may come across the option to pick between secured or unsecured credit agreements.
When you borrow money with only your commitment to repay, it is unsecured. On the other hand, when you place collateral to back up the borrowed money, it is secured.
This is the basic difference between the two, and understanding the other important aspects is important before you borrow. Keep reading to explore the secured loan vs unsecured loan debate and determine the better pick for your next loan.
What Are Secured Loans?
When you back your borrowed amount by an asset like a car in the case of auto financing or a house for a mortgage, it is considered a secured loan. Posting assets as collateral is the most important aspect of secured credit. A repayment mortgage or a HELOC (home equity line of credit) are common examples of borrowing where your home is at risk if you fail to make repayments.
Your agreement would mention it in clear terms that any failure to make payments would give the lender the right to repossess the collateral. Once your assets are repossessed, the lenders would sell them to use the proceeds to clear the debt. If the asset value falls short of the expected amount, you will have to make additional payments to cover up for the borrowed amount.
When you post collateral, you can expect to receive a lower APR (annual percentage rate). This makes secured loans an attractive option for borrowers who do not have good credit scores.
It is important to consider the consequences of repayment failure given assets like your house or vehicle are at stake of forfeiture or repossession.
What Are Unsecured Loans?
When you borrow an unsecured personal loan, you do not post collateral to back up the borrowed amount. Accordingly, lenders cannot seize your property or assets if you fail to repay. Most personal loans come in an unsecured format.
Student loans are one of the most common examples. You do not place any asset as collateral to cover the borrowed amount. Therefore, accessing an unsecured amount can be tough as it depends on your ability to repay and creditworthiness.
You should have a good credit history and a strong income to qualify for unsecured funds. It also means that the amounts lent may be smaller because lenders don’t have collateral as security in case of non-payments. The APR will also be on the higher side when compared to a similar borrower applying for the same amount of secured credit.
When you default on payments, the first major consequence is felt by your credit score which is directly affected. You might also have to face debt collectors attempting to recover the unpaid sum. Ultimately, the lender would have to challenge you in the courts and win the judgment to get the money back or find another way to recoup the losses.
These loans are ideal for borrowers who have a good history and do not want to keep any asset as collateral. As a borrower, you can use this money for many different reasons like home improvement, large purchases, or debt consolidation.
Other Forms Of Unsecured Loans
The three major types of unsecured credit are as follows:
- Credit Cards - A credit card is an open line of credit that allows you to borrow up to a fixed limit. You can borrow as long as you can repay the principal amount at some point along with interest. Therefore, it can be a revolving cycle of borrowing, spending, repaying, and borrowing again. Since these are unsecured loans, they will be issued based on your creditworthiness.
- Personal Lines Of Credit - These are similar to credit cards as they give you access to a fixed amount. You need to pay interest on the amount you use and not the entire amount you are eligible for. The interest rates here are usually lower than credit cards, and also the borrowing amount would be typically higher.
- Student Loans - Interest rates depend on your credit score and financial situation. Private loans would charge higher interests as compared to federal ones.
Before You Take A Loan
If you have decided to borrow, you should target an APR that is below 36%, whether the funds are secured or unsecured. Most importantly, you must check your credit score before applying. With a higher score, you should get qualified with a lower interest rate. You can also consider pre-qualifying for loans, which will give you a chance to study the rates and terms of different lenders knowing you have already got access to the rates.
If your application is rejected for both secured and unsecured financing, no credit check loans might seem attractive. However, they can quickly land you into a debt trap. Payday loans and title loans are common examples of financing that is accompanied by unusually high interest rates, where you can expect to see APRs of 300% or more.
With this in mind, definitely consider alternative sources which will prevent you from falling into a debt trap. Moreover, always work on your credit score to keep affordable and accessible financing available.