While some people swear by a cash-only lifestyle, the truth is that credit becomes inevitable at some point in life. You may encounter an emergency that requires immediate financing, where a personal loan can be invaluable. Additionally, if you’re undertaking a capital-intensive project and can’t raise 100% of the necessary funds, a credit facility becomes essential.
When considering your credit option, you might have to decide between a secured or unsecured loan.
What is a Secured Loan?
A secured personal loan is backed by collateral. This is where you take a loan against your asset or property. The most common types of secured loans are mortgages and car loans. In these types of loans, failure to honor your monthly installment calls for seizing the security, and in some cases it may go to the extent of disposing of the asset to recover the outstanding loan.
Here are the kinds of assets that you can use to secure your loan
- Real estate properties
- Bank Account (Savings Account, CDs, and Money Market Account)
- Motor Vehicle
- Stocks, Mutual Funds, or Bond Investment
- Insurance policies
- High-end collectibles such as precious metals etc
Characteristics of a Secured Loan
Require Security – A secured personal loan must be backed by a security. You are expected to attach a security to the loan which minimizes the risk on the part of the lender. On the other hand, it is detrimental to the borrower because you risk losing your property in the event you default on paying the loan.
Easier to Qualify – Secured loans are less risky for the lender because they can take up your property and recover the defaulted loan from it. The attached security gives the lender the confidence to advance money to the borrower as they feel that their money is secure since they can recover from the provided security.
Cheaper than other loans – Since secured loans pose less risk to lenders, they often come with lower interest rates than other types of loans. Offering collateral for your loan is an effective way to reduce its overall cost.
Higher Borrowing Limits – Lenders are willing to advance as much as you want, provided you can pay the monthly installments. The security gives them the confidence to lend a huge sum of money as they are covered by the security attached. In case you default on the loan they repossess the property and recover the outstanding loan amount.
What is an Unsecured Loan?
An unsecured personal loan is a loan that is not backed by collateral. So, if you don’t pay the loan the lender stands to lose all of the money they lend to you. For this reason, unsecured loans are more riskier for the lender which makes them more expensive in terms of the interest charged.
Characteristics of an unsecured loans
No Collateral – These loans are not secured by any assets. Once you meet the lender’s requirements, the loan is granted without attaching any property to it. As a result, these loans pose a higher risk for the lender.
Tough to Qualify – Since these loans are considered high-risk, lenders impose stringent rules that exclude many borrowers. They conduct thorough appraisals to ensure they lend only to individuals who can reliably repay the loan.
High Interest Rates – Since the lender doesn’t have a way of recovering their money upon default they charge a high interest rate
Smaller Amounts – Unlike secured personal loans unsecured loans have smaller loan approval rates. This is because lenders are hesitant to lend money which they are not sure how they’ll recover in case of default.
Final Thought
The decision to apply for a secured or unsecured loan depends on your specific situation. With the information provided above, you are better equipped to evaluate which loan best suits your needs.
