To become a prudent borrower, you must first understand the various types of loans at your disposal. Loans can broadly be classified into secured and unsecured loans. Secured loans are borrowed against assets. On the contrary, unsecured loans do not require collateral. That is the fundamental difference. Nevertheless, knowing that alone is not enough. There are more specific differences between the two types of loans. Understanding these differences will help make wise borrowing decisions. For example, you will know when to take a secured loan, and when to go for unsecured loans.
Unsecured loans do not require any collateral. Examples of unsecured loans include student loans and quick personal loans most people qualify for through online applications. Unsecured loans present higher risks to lenders than secured loans because there is no real guarantee to reclaim at least some of the value of the loan in case of default. The unsecured loans, therefore, tend to have higher interest rates, shorter repayment periods, and lower loan limits.
The relatively no-nonsense way in which unsecured loans are managed by lenders doesn’t detract from their value as a useful financial instrument in certain situations. They help those who need to borrow money but who don’t have a high enough credit score, available cosigner, or ability to put adequate property up as collateral. Folks need a way to get funds to cover the costs of education or simply putting food on the table in between paydays.
There are banks and other lenders who may offer low-interest unsecured loans. The catch, as one can imagine, is that only borrowers with glowing credit scores will be approved. These institutions essentially have 100% faith in the person’s ability to repay the debt on time as promised without delay.
When taking a secured loan from a lender, you have to present collateral. These are assets that the lender will hold until the loan is fully settled. In the event of a default, the lender will sell the assets to recover their money. Usually, collateral is real assets such as motor vehicles and title deeds. Some lenders also accept financial assets such as stocks and bonds. The most common secured loan examples are mortgages and car loans. These loans have a special arrangement in that the vehicle or home you are buying can act as the security.
Most lenders cannot give you a large loan without an assurance that you will pay. It follows, therefore, that secured loans are the only option if you want to borrow large sums of money. Knowing that your assets are at stake will pile pressure on you to pay.
Secured loans present fewer risks for lenders than unsecured loans. Lenders can, therefore, afford to offer higher sums, lower interest rates, and longer repayment periods. Some secured loans such as mortgages have additional benefits such as tax deductions. The home mortgage interest tax deduction is directly proportional to the interest charged. As a borrower, losing assets such as a home can be painful. It is, therefore, vital to ensure that you have the means to pay before taking a secured loan.
Which loan is better?
The answer to this question will depend on your financial needs and capacity. Secured loans are suitable for financing projects that require a lot of money. Unsecured loans are ideal for recurrent expenditure. Other factors to consider when taking a loan include the cost of credit and the repayment period.
Lenders have unique loan terms. For example, the loan limit of lender A can be different from that of lender B. It is, hence, essential to compare different lenders before borrowing a loan. Failure to pay a loan attracts severe penalties. When taking a loan, you should know how you will pay it. One way of avoiding loan defaults is using the loan for the intended purposes.