Sooner or later, most of us are confronted with the need for a loan. When that time comes, we’re faced with many decisions — one being secured or unsecured. And many of us are not sure what the difference is. Broadly, secured loans are tied to an asset, like your home or automobile. Unsecured loans are not tied to any specific asset. The more you know about these loans, the more wisely you can borrow money.
What is a Secured Loan?
Lenders often issue loans secured by a specific item of personal property. This item might be your house, car, a boat, or even stocks or bonds. That property is used to secure the loan by allowing the lender to maintain ownership rights of the asset until the loan is repaid. So, if you fail to repay the loan or meet the terms of your loan agreement, the lender can legally seize and sell your property to repay the loan — sometimes referred to as loan collateral.
The lender also places a lien on the property — meaning if you sell the property the lender is entitled to recoup the remaining loan balance before you receive your money from the sale.
The most common type of secured loan is a mortgage–secured by the house being purchased. If you stop making your mortgage payments, your lender could foreclose on the home and sell it to pay off the mortgage. If you sell your home, you have to pay off your mortgage immediately.
Advantages of Secured Loans
- You can borrow larger amounts because lenders are confident they’ll get their money back, either from loan repayments or sale of the property.
- Secured loans typically come with a lower interest rate than unsecured loans because the lender is taking on less financial risk.
- Some secured loans, like mortgages and home equity loans, allow eligible individuals to take tax deductions for interest paid on the loan each year.
Disadvantages of Secured Loans
- If you encounter financial difficulties and cannot repay the loan, the lender could seize the property.
- The amount borrowed can usually only be used to purchase a specific asset, like a home or a car. Home equity loans are an exception.
What is an Unsecured Loan?
This kind of loan doesn’t involve naming specific property as collateral. Instead, the loan is issued on your ability to repay the loan. This ability is based on things like income, savings, employment or credit history. Some common types of unsecured loans include credit cards, student loans and personal loans.
Advantages of Unsecured Loans
- You may be eligible to get an unsecured loan even if you do not own property to put up as collateral.
- The application process for an unsecured loan often goes faster than the process of getting a secured loan.
Disadvantages of Unsecured Loans
- Interest rates on unsecured loans are often higher than rates on secured loans because the lender has a higher risk level of loans not being repaid.
- Unsecured loans can be harder to get if you don’t have good credit or regular income. You may need to find a co-signer with good credit history and solid income to sign the loan documents with you.
It’s always good to understand the differences between loans when you apply for one. That doesn’t mean you shouldn’t ask questions when you apply, it just gives you a better understanding and provides you with background to ask the right questions. Make sure you understand all the terms of your loan.
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