Secured V/S Unsecured Loan

Secured V/S Unsecured Loan

What Are Secured Loans?

    Secured loans are loans that are backed by an asset, like a house in the case of a mortgage loan or a car with an auto loan.This asset is collateral for the loan. When you agree to the loan, you agree that the lender can repossess the collateral if you don't repay the loan as agreed.

     Even though lenders repossess property for defaulted secured loans, you could still end up owing money on the loan if you default. When lenders repossess property, they sell it and use the proceeds to pay off the loan. If the property doesn't sell for enough money to completely cover the loan, you will be responsible for paying the difference. Secured debt financing is typically easy for most consumers to obtain. Lenders take on less risk by lending on terms that require an asset held as collateral.

      As this type of loan carries less risk for the lender, interest rates are usually lower for a secured loan. A prime example of a secured debt is a mortgage, where the lender places a lien, or financial interest, on the property until the loan is repaid in full. If the borrower defaults on the loan, the bank can seize the property and sell it to recoup the funds owed. Lenders often require the asset be maintained or insured under certain specifications to maintain the asset's value. For example, a mortgage lender requires the borrower to protect the property through a homeowner's insurance policy. This secures the asset's value for the lender until the loan is repaid. For the same reason, a lender who issues an auto loan requires certain insurance coverage so that in the event the vehicle is involved in a crash, the bank can still recover most, if not all, of the outstanding loan balance.

What Are Unsecured Loans?

     The same isn't true for an unsecured loan. An unsecured loan is not tied to any of your assets and the lender can't automatically seize your property as payment for the loan. Personal loans and student loans are examples of unsecured loans because these are not tied to any asset that the lender can take if you default on your loan payments.You typically need to have a good credit history and solid income to be approved for an unsecured loan.

     Loan amounts may be smaller since the lender doesn't have any collateral to seize if you default on payments.

     Unsecured debt is the opposite of secured debt, and, like its name, it requires no security for the loan. Lenders issue funds in an unsecured loan based solely on the borrower's creditworthiness and promise to repay. In days past, loans were issued this way with a simple handshake. If a borrower fails to repay the loan, the lender can sue the borrower to collect the amount owed, but this can take a great deal of time, and legal fees can add up quickly. Therefore, banks typically charge a higher interest rate on these so-called signature loans.

      Also, credit score and debt-to-income requirements are usually stricter for these types of loans, and they are only made available to the most credible borrowers. Other examples of unsecured debts outside of loans from a bank include credit cards, medical bills and certain retail installment contracts such as gym or tanning memberships. Credit card companies issue consumers a line of credit with no collateral requirements but charge hefty interest rates to justify the risk.