Most loan types out there fall into one of the following categories – secured or unsecured. Loan customers can choose between these two types of lending options. Secured loans are secured against collateral, i.e. your assets. This means that they have a higher borrowing amount and lower interest rates. On the other hand, unsecured loans come with a faster approval process.
Secured loans – definition and examples
Secured loans are guaranteed with some kind of collateral. The item that is being purchased with the loan amount, a house or a car, for example, can act as collateral. Therefore, a lien is placed on it. The lender will take possession of the deed or title until the full repayment of the loan, including fees and interest. Other forms of acceptable collateral include stocks, bonds, and property.
Secured loans are preferable in order to obtain larger amounts of credit. This is due to the lender’s need for a guarantee that he will be repaid in any case. Therefore, the lender is interested that the borrower would have something valuable at stake to motivate him.
Of course, secured loans are not limited only for the purpose of a new purchase. They can also be home equity loans. In that case, the current market value of that house minus the owed amount is taken into account. If that is the case, any failure to repay may lead to losing that house.
Secured loans come with lower rates. They also provide higher borrowing limits and longer repayment periods. This is due to the provided guarantees that the loan will be repaid. On the other hand, if the consumer cannot repay in full on time, the lender may be able to legally sell the asset in order to be repaid.
Types of secured loans include home equity loans, car loans, boat or recreational vehicle loans, and mortgage.
Why are secured loans and lines of credit preferred?
Secured loans or lines of credit have certain advantages. Through them, a customer can usually obtain a larger amount of money because he can guarantee their repayment with his property.
It is true that the approval process takes longer because they need collateral and it has to be processed and verified. On the other hand, the customer will benefit from the lower interest rates.
When facing larger home renovations, it may be advisable to go with a secured line of credit in order to obtain more funds on a smaller interest rate. For outstanding debts, there is the option of a personal consolidation loan secured by the borrower’s assets. A secured personal loan can help with monthly payments while having lower interest rates than credit cards.
Nevertheless, even with a secured loan, the borrower’s credit may be damaged if payments are not made. Not only that, the collateral may be sold by the lender which may turn out to be insufficient to repay the loan.
What is an unsecured loan?
Unsecured loans usually include credit card purchases, education, and unsecured personal loans. Being unsecured means that lenders take more risk. This is due to the fact that there is no collateral to recover in case of default.
Therefore the interest rates of unsecured loans are much higher. It is easier to be turned down for an unsecured loan, but such customers may still be able to obtain secured loans if they possess something valuable or if they need the loan to purchase something valuable.
When applying for an unsecured loan, lenders expect that their customers to repay them based on their financial resources. Lenders make their decision whether or not to grant the loan based on five basic criteria – character, capacity, capital, collateral, and conditions. They are used as a basis for assessing the customer’s ability to repay the debt.
Lenders research their clients’ borrowing history for former successfully repaid loans. Based on the credit reports, the client’s credit score is calculated. Good credit is important when applying for an unsecured loan but even bad credit can be rebuilt.
Another important factor when applying for an unsecured loan is the borrower’s income. It must be sufficient to be able to repay the loan. Proof of income includes bank statements and tax returns.
If the customer’s credit and income aren’t good enough to qualify for an unsecured loan, a co-signer may be a sufficient guarantee for the lender.
Unsecured loans most notably include credit cards, personal loans, and lines of credit, some types of home improvement loans and student loans, and unsecured business loans.
Why are unsecured loans and lines of credit preferred?
The most notable advantage of an unsecured loan is that there’s faster approval that excludes most of the paperwork required for a secured loan. Therefore, unsecured loans are actually harder to obtain because lenders require a much better credit score to compensate for the lack of collateral.
Also, unsecured loans that are faster to get come with a higher interest rate. There are some common cases when borrowers choose unsecured loans. These are the purchase of a vehicle, home renovations, medical and educational expenses. Debt consolidation is also a common reason for taking out an unsecured loan. It should be noted that an unsecured car loan takes less time to process than a secured loan.
It is preferable to take out an unsecured personal loan for home renovation because the borrower can have access to the amount quickly while the end costs are predictable. Ongoing expenses like tuition and medical bills would likely require an unsecured personal line of credit.
Outstanding debts may be consolidated with a signature loan that has interest rates lower than these of credit cards.
Unsecured loans can be revolving. The first type is a loan that has a certain credit limit that can be spent, and after repaying – spent again, such as credit cards and personal lines of credit. On the other hand, term loans are being repaid in equal installments. The loan has to be repaid by the end of the term.
Unsecured loans offered by alternative lenders
Payday lenders and companies offering merchant cash advances are considered alternative lenders and they usually offer online loans that are not guaranteed by collateral. Of course, they do require some forms of securing their payment. Payday lenders accept a postdated check from their clients or have them agree to an automatic withdrawal from their checking accounts. Online-based merchant cash advance providers demand that their clients pay a percentage of the client’s online sales using a payment processing service. Therefore, these loans are unsecured, although having some partial guarantee.
Defaulting an unsecured loan
If a loan customer cannot repay a secured loan, the loan provider can repossess the asset and sell it, in order to cover his losses. The unsecured loan lender, on the other hand, cannot claim any property. There are other actions that a loan provider can take. He can commission a collection agency or he can sue the borrower. The court has its own methods of making the borrower repay, such as garnishing his wages or placing a lien on his house.
Types of unsecured loans
Signature loans are a type of unsecured loan that is secured only by the client’s signature. They are offered by banks and credit unions and have no obligatory purpose, so that the borrower may use them any way he wants. They are usually installment loans which mean that they are repaid through equal monthly installments. They require good credit because they have low interest rates. They also help to build a credit score.
The borrower can borrow whenever and whatever he needs as long it doesn’t exceed his credit limit. Nevertheless, they have high interest rates. There are many online lenders so it isn’t hard to find an offer.
Student loans are unsecured loans that are used to fund the educational expenses of students. They usually have features unavailable to other types of financing, like flexible repayment options, grace periods and interest subsidies. Good credit may not even matter. The only essential requirement is to be a student. They can be obtained through the Financial Aid office of the particular school.
These allow borrowing from individual lenders and not from a traditional lender such as a bank. There are websites that allow their clients to post a loan request online, and people may fund your loan. These loans are usually fixed-rate installment loans with competitive interest rates. Good credit is generally required.
Unsecured loans and bad credit
It is much harder, but not impossible to get an unsecured loan with bad credit. This would require higher interest rates than a borrower with good credit score. If the offered lending terms don’t suit the client, he must focus on building a good credit score in order to be offered better terms. A borrower can improve his credit score by borrowing and repaying small loans on time.
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