If you’ve ever come across the terms “unsecured” and “secured” loans but find it difficult to differentiate between the two, don’t worry. This article will help you understand the distinctions between these two types of loans and provide insights into how they work.
An unsecured loan is a type of loan that doesn’t require any collateral. Unlike secured loans that rely on a borrower’s assets as security, unsecured loans are approved based on the borrower’s creditworthiness. Examples of unsecured loans include personal loans, student loans, and credit cards.
How Unsecured Loans Work:
Unsecured loans, also known as signature loans or personal loans, are approved without the need for properties or other assets as collateral. The terms of these loans, including approval and receipt, are primarily contingent on the borrower’s credit score. Generally, borrowers must have a high credit score to be eligible for unsecured loans. In contrast, secured loans require borrowers to pledge some form of asset as collateral for the loan, increasing the lender’s security. Mortgage and car loans are common examples of secured loans.
In some cases, lenders may allow loan applicants with insufficient credit to provide a cosigner. A cosigner takes on the legal responsibility to repay the debt if the borrower defaults. This happens when a borrower fails to make interest and principal payments on the loan.
Key Points of Unsecured Loans:
- Unsecured loans rely solely on the borrower’s creditworthiness and do not require collateral.
- These loans are riskier for lenders, leading to the need for higher credit scores for approval.
- Credit cards, student loans, and personal loans are common examples of unsecured loans.
- Lenders decide to approve an unsecured loan based on the borrower’s creditworthiness, but laws protect borrowers from discriminatory lending practices.
In the event that a borrower fails to repay an unsecured loan, the lender may commission a collection agency to retrieve the debt or take legal action against the borrower.
A secured loan is backed by collateral, which is a financial asset owned by the borrower, such as a home or a car. This collateral can be used as payment to the lender if the borrower fails to repay the loan. The concept behind a secured loan is simple: lenders accept collateral as security, incentivizing borrowers to make timely repayments.
Types of Secured Loans:
Secured loans come in various forms, but the three most common types are as follows:
- Mortgage Loan: This type of loan tops the list of secured loans and is secured by the borrower’s property.
- Vehicle Loan: These loans cover automobiles, boats, motorcycles, and even private airplanes, with the respective vehicle serving as collateral.
- Secured Credit Cards: Designed for consumers with no credit history, secured credit cards are an excellent way to establish credit and improve credit scores. Unlike mortgage or vehicle secured loans, secured credit cards require a cash deposit as collateral.
Obtaining a loan is a significant financial decision that necessitates careful planning and preparation. It is essential to find the right secured loan that suits your unique needs, along with a solid plan to repay the borrowed money. Generally, it is advisable and strongly recommended that borrowers consider secured loans over unsecured ones due to the added security provided by collateral.