While some people believe in cash-only lifestyle, most of us rely on credit to pay for our life’s big expenses over time. When you want to buy a big-ticket item like a house or a car, start or grow a business, renovate your house or pay for your education, you can apply for a loan at either your local back or online to help you cover the cost.
Now, when considering your credit options, you might have to decide between a secured and unsecured loan. Secured loans require that you offer up something you own of value as collateral in case you can’t pay back your loan, whereas unsecured loans allow you borrow the money straight, after the lender considers your financials to offer you the loan.
Understanding the differences between the two is very important in achieving financial literacy which can have a long-term effect on your financial health. We have tried to highlight the differences below for these two types of loan –
Secured Loan – Secured loans are always protected by an asset. The item purchased like home or a car can be used as a collateral. The lender in this case will hold the deed or title till the time loan is paid in full. Other items are also used to back a loan too, that can include – stocks, bonds or personal property. These are the most common ways to borrow money. A lender is only going to provide a big ticket loan only with a promise that it will be repaid in other words you are providing some security that your loan will be repaid. Here the risk is if you are not able to repay your secured loan, the lender has the right to sell your collateral to pay off the loan.
Advantages of secured loan are –
- Lower interest rates
- Higher loan amounts
- Longer repayment terms
Some common examples of secured loans include – Home Loan, Home equity line of credit, Vehicle loans etc.
Unsecured Loan – Unsecured loans are just reverse of secured loans. Lenders take more of a risk by making this loan offer, because there is no asset to recover in case of default. This is why the interest rates are higher. If you don’t get approval for unsecured credit, you still have the option to obtain secured loans. But you must have something of value that can be used as collateral.
The lender will judge you on the basis of few parameters like – credit score, employment history, income capacity, existing debt, savings portfolio, personal assets and loan history. These parameters may vary for different types of loan.
Some common examples of unsecured loan include – Credit cards, Personal loans, Student loans etc.
Is a Secured Loan Better than an Unsecured Loan?
Usually, contract on a secured loan is usually more favorable for a borrower than an unsecured loan. Often times, the repayment periods are a lot longer and relaxed, interest rates are lesser, and borrowing limits are higher. All these factors imply that opting for a secured loan is more beneficial for a borrower.
Ever lenders generally prefer secured loans over unsecured loans as they are less risker to offer. Since borrowers have to provide an asset as collateral to obtain a secured loan, there is a degree of certainty in the mind of the lender. The lender is assured to get the money back, and even if he doesn’t the asset can be used to recover the lost amount.
As a thumb rule, only borrow when you really need and can afford to pay it back. Please make sure you are comfortable with the repayment schedule. Just because you can get a loan it doesn’t mean you should go for it. So, take your time and do your research before you sign on the dotted line.