Nowadays many secured and unsecured loans are being offered in the market by the lenders. But do you actually know the meaning of what is a secured and unsecured loan? And how is one supposed to choose between the two?
In this post by the loan experts at CreditMantri, we distinguish between the two for you to have a clear understanding on how they work. Once you understand the differences, depending upon your requirements and convenience you can decide which suits you best.
What are secured loans?
Secured loans are offered through a collateral. Any legal item that holds a monetary value can be pledged as collateral to the lender. Generally, property or a vehicle (on which you take the loan) is pledged as a collateral to the lender while taking a secured loan. The lender holds rights to that collateral until the said loan is repaid.
In the unfortunate case, that you are unable to repay the loan, then the lender will notify you with a final warning and sell off the collateral and recover the loaned amount. The loan processing fees and interest rates are lower for a secured loan.
Advantages of Secured Loans:
- Lower Interest Rates
- Higher Borrowing Limits
- Longer Repayment Terms
Examples of Secured Loans:
- Home Loans – In a home loan, the borrower takes a loan to purchase a new home. The home is hypothecated by the lender until the borrower repays the loan completely.
- Loan against property – A loan against property is a loan to pay for a home. Your monthly loan payments will consist of the principal and interest, insurance coverage plus taxes.
- Home Equity Line of Credit (HELOC) – A home equity line of credit (HELOC) allows you to borrow money through your home’s equity acting as collateral.
- Vehicle Loans – As the name implies, the borrower takes a vehicle loan to purchase a car, bike or any other vehicle. The vehicle is pledged as collateral.
What are unsecured loans?
Best part about this type of loan is it does not require any collateral. Then you might ask how is this possible? That is because here you will be given the loan based on your creditworthiness.
The more your credit scores the better. Other eligibility criteria like income, employment type, etc. play a huge factor while availing this loan. This will vouch for your repayment ability and make you look more favorable. Other factors which will be scrutinized are your credit repayment history, debt to income ratios, job experience, etc. These factors render you eligible for an unsecured loan. Only turn off is that an unsecured loan comes with a higher interest rate and processing fees because the risk bearing factor is also high on the lender’s side.
An unsecured loan provider will trust you based on the five C’s of credit:
- Capacity – income and current debt
- Capital – investment accounts or funds in savings
- Character – employment status, credit score, repayment history, etc
- Conditions – the terms and condition of the loan contract
- Collateral – personal assets offered as collateral, like a home or car, although it won’t mostly be required
Based on these 5C’s a borrower’s ability is measured to repay the debt, and can include the borrower’s situation as well as general economic factors. Also note that the five C’s of credit are different for personal loans and business loans.
Examples of Unsecured Loans:
- Credit Cards – There are different types of credit cards, but general credit cards are billed once a month and interest charges are applied if you do not pay the balance in full.
- Personal Loans – These loans can be used for many purposes, and can vary depending upon the price range.
- Personal Lines of Credit – A personal line of credit is similar to a credit card and has an approved limit that you can use when required. You can use this line of credit for almost anything, and you will be charged interest only on the amount spent.
- Student Loans – Student loans help to pay for college expenses and are available through both private lenders and the Department of Education.
- Home Improvement Loans – also known as home renovation loans are offered to upgrade and fix repairs at a home.
Here are the key differences between a secured loan and unsecured loan. Based on your needs, this will help you decide which one suits you best.
- Collateral – Secured loans do require collateral whereas unsecured loans do not require collateral as they are given mostly on the basis of your creditworthiness.
- Interest charges and processing fees – Secured loans have a comparatively lower rate of interest with no processing fees whereas unsecured loans have higher interest rates with processing fees.
- Availability – Secured loans are easily available in the market because it is less riskier.
- Repayment period – Secured loans have a longer repayment period than unsecured loans.
- Risk factor – unsecured loans have more risks than secured loans for both the bank and the borrower.
Make the best financial decision when you are taking a loan. Knowing how and when to choose a loan can be a challenge, especially if you are already facing financial challenges. If you are having trouble keeping up with all your bills and want to opt for a loan but are confused on which one to take, it might help to talk with someone. CreditMantri offers free consultations and guidance to help our clients to manage debt, save money, and meet their financial goals. Call us today. It’s free, confidential, and no pressure.