When you need access to extra cash, you may think about applying for a loan. Loans make it convenient for you to get access to the cash you need while extending the payments on the borrowed funds out for several years or longer. When you are thinking about applying for a new loan, you have two primary options to consider. These are secured and unsecured loans. With a closer look at the primary differences between these two types of loans, you will be able to more easily search for the right type of loan to satisfy your current need.
Understanding the Differences Between Secured and Unsecured Loans
A secured loan is one that is backed by collateral. You may pledge collateral that you currently own, and this collateral generally should be owned free and clear or without the hindrance of other loans attached to it. An unsecured loan, on the other hand, is generally backed by you personally. The lender will not have any collateral to seize if you default on the loan. With this in mind, the lender may place more emphasis on your credit rating, income and financial stability when analyzing the loan.
A Closer Look at Differences in Loan Rates and Terms
With a secured loan, the lender has the ability to repossess the asset that is used as collateral if you default. Typically, the lender will ensure that the asset has significant value that is more than the requested loan amount, and this is often done through an appraisal on the asset. If you default, the lender can recoup most or all of its losses by selling the asset. Therefore, the risk of loss for the lender is minimal, and the lender can therefore issue great rates and terms. With an unsecured loan, the loan is only moderately risky if you have a great financial profile as a borrower. Even the most well-qualified borrower may fall on hard times, so there is always some risk for the lender. With this in mind, these loans generally have higher rates and less advantageous terms than secured loans. However, if you have good credit, you may find that an unsecured personal loan still has better rates and terms than a credit card has.
Determining Which Assets to Use
Because secured loans have better rates and terms, many people will consider using a secured loan initially. Some will use the loan funds to purchase the asset. This is common with a car loan. If this is the case, you will not need to determine an asset to pledge. On the other hand, if you are applying for a personal loan for another purpose, such as for debt consolidation, you need to review your assets. Consider the approximate value of your assets, such as cars, boats and even CDs and bonds. Then, consider which assets you may be willing risk losing if you default on the loan.
The Importance of Understanding Risk
Risk is always a concern when you are applying for a loan. When you default on an unsecured or a secured loan, your credit rating can be seriously damaged. When you default on a secured loan, you also run the risk of losing your asset. Defaulting on an unsecured loan may result in the creditor suing you for damages in court.
Finding an Affordable Loan
With the risks of a personal loan in mind, it is important to ensure that the loan you obtain is affordable. Review the estimated loan payment in conjunction with your budget to ensure that the payment is comfortable and manageable for you. Because everyone will run into financial issues from time to time, take the next step to review your savings account balance. Your savings account can act as a financial backup plan. With ample funds in your savings account, you can more easily navigate through a layoff, a serious medical issue or other situations that may arise.
A personal loan can help you to achieve major goals you have, such as buying a car, consolidating debt, opening a new business and more. Regardless of the plans you have, you understandably want to set up a loan that is affordable and minimally risky for you. Consider the pros and cons of unsecured versus secured loans as you make a decision about which type of loan to apply for.
Christine has a solid background in personal finance as she spent the last eight years working at one of the biggest banks in the US. She managed her own team of financial advisors that helped hundreds of people with their financing needs. Her innate understanding of different financial products and loans helped her move up the ranks quickly after graduating with a degree in Business Administration.