What is a Secured Loan?
When it comes to borrowing money, there are a lot of financial terms floating around. You have probably heard about secured loans before, but do you really know what they are and how they work? A secured loan is a loan that is secured via a borrower's asset. The asset, oftentimes a car or piece of property, becomes collateral for the loan.
In this arrangement, the debt is secured against the collateral, so if the borrower fails to uphold his or her end of the deal, the lender takes possession of the asset and may sell it to regain some or all of the amount originally loaned. If the lender sells the item used as collateral and still does not have enough money to regain the total amount of debt, he or she can obtain a legal judgement against the borrower for the remaining amount.
Secured loans are an attractive option for lenders, because they eliminate an element of risk. The creditor does not have to put so much on the line, because he or she can take the property if the debt is not paid in the specified amount of time. If a borrower has a low or nonexistent credit score and has trouble getting a loan, it can be easier to borrow money by pledging a personal asset. Also, the terms of a secured loan may be more favorable than those available for an unsecured loan. A lender may offer a loan with flexible repayment periods or competitive interest rates since there is already a security measure in place.
Types of Secured Loans
One of the most common examples of a secured loan is a mortgage loan. As you probably already know, a mortgage loan is secured by collateral - a piece of property, typically the borrower's home. If the borrower defaults and is unable to afford his or her mortgage, the home will go into foreclosure and the lender, in this case, the bank, will take possession of the property and sell it in order to recoup the loss. Foreclosures were widespread during the recent housing crisis, because many Americans were unable to make their mortgage payments and subsequently defaulted on their secured loan.
Another common type of secured loan is a car title loan. In this type of arrangement, a borrower pledges his or her car as collateral and must hand over the free and clear title prior to receiving the loan. The amount of money a borrower can get is based on the current market value of their vehicle, but the car stays in the debtor's possession throughout the duration of the loan. At the end of the payment period, if the title loan is not paid in full, the lender has the option to repossess the auto.
However, repossession is rare, because it is a costly and time-consuming process. Typically, a borrower is granted an extension and ultimately keeps his or her car. Car title loans are a popular way for individuals with poor or nonexistent credit to get their hands on some fast cash, because the value of their car is ultimately much more important than their credit score.
What is an Unsecured Loan?
Now that we have explored secured loans, let's take a look at unsecured loans and how they differ from their counterpart. Unsecured loans include things like credit card purchases, loans for educational purposes, or personal loans. Unsecured loans, as the name implies, are riskier for the lender, because there is no property or assets to recover in case of default. As a result, the interest rates are considerably higher for an unsecured loan and the repayment terms may be less flexible.
If a borrower is approved for an unsecured loan, the lender has assessed his or her creditworthiness and believes they will be able to make the required payments on time. As you can imagine, there is often a more extensive application process for an unsecured loan, because the creditor wants to be absolutely sure they are working with a solid candidate. Individuals with a high credit rating are more often approved for unsecured loans, because they have proven themselves based on payment history.
There are different types of unsecured loans, so they may come with a fixed interest rate and be due at the end of a predetermined amount of time, or be a revolving line of credit with a variable interest rate. With so many available options, it is important to do your homework prior to applying for a loan - whether secured or unsecured. As long as you know what you're agreeing to beforehand, you should have no problem getting the money you need to tackle both major and minor expenses.