When one applies for a loan from a bank or any other type of financial institution, the said bank has two options of going about lending the money. It can give it to you based solely on the promise that you will be paying it back according to the agreement you signed, or it can ask you to use an asset which will act as a security or guarantee for the loan. Now you know what is the main difference between what is a secured loan versus an unsecured one. Do you want to know more details? Here they are.
What Is a Secured Loan?
As pointed out in the introduction, a secured loan is that type which is protected by a particular asset or any other kind of collateral. In other, simpler words, when you apply for a secured loan, the bank that is supposed to issue it asks you to put down a very valuable asset so that you can have something with which to back up the loan.
In case you cannot make the payments for whatever reason, the bank then has the right to take the asset you put down and sell it so that it can get its money back. This is the reason why they typically ask a loaner to use his or her house as collateral, because it’s probably the most expensive item they own.
If and when you agree to this course of action, a loan can and will be placed on that particular item. It means that the bank or institution which is giving you the money gets to hold the deed to it until you have paid back every last cent as well as the interest and all the applicable fees.
If for some reason, you do not wish to put down your house, you can also use stocks, bonds, and any other personal properties. However, they must be valuable enough to cover the original sum you borrowed plus the interest plus the fees. This is why it’s unlikely that one has something of higher value than their house.
When and if you do put it down, it will assure the lender that you will do absolutely anything in your power to pay back all the money that they’ve lent you.
One interesting thing about secured loans is the fact that they are not meant just for new purchases. If you want one, you should know that you can also use it as a home equity loan or even a home equity line of credit. This type of loans is based on the amount represented by your home equity. This amount is just the current market value of your home minus the sum that you owe. Therefore, your home will be used as collateral. Evidently, if you fail to make your payments, you could lose your house.
When thinking about the answer to the question what is a secured loan, you should also reflect on what advantages it offers. First of all, the interest rates will always be lower with this type of loan because you have something to back it up. Apart from that, the borrowing limits are also higher, and the repayment terms are longer. These two factors mean that are able to borrow a lot more money than with other types of loans and that you have more time to pay it all back.
Here are some examples so that you can better understand what is a secured loan.
- Auto loans, both used and new
- Home equity lines of credit
- Boat loans
- Loans intended for recreational vehicles.
What Is an Unsecured Loan?
As opposed to secured loans, the unsecured ones do not require you to give up the deed to a particularly valuable asset you possess so that you can guarantee the payment of the loan itself. Seeing as this is the case and lenders do not have a safety net, so to say, they take a lot more risk when they decide to grant you the loan for which you asked.
Apart from the risk they’re taking, any bank or other financial institutions that grant unsecured loans will always ask for higher interest rates. The reason is that they need to match the potential risk of you not paying back the sum of money they’re lending you with something. That something comes in the shape of a bigger interest.
If and when you decide to go for an unsecured loan, the bank that issues it out to you works on the premise that you will pay back the sum based on your financial situation. Therefore, they need to assess it, and they do that by looking at your credit score. This is an actual figure to which they come after analyzing the following set of criteria:
- The way in which you behaved in the past with other credits.
- How much money you make and how much money you spend every month.
- How you dealt with your student loans, if you had any.
- More menial things, such as how you fast and reliable you were in the past in paying your bills and your rent.
The credit score is judged taking into account what have come to be known as the five Cs of credit: capacity, character, collateral, capital, and conditions. Essentially, these are all criteria that will help the bank assess just how creditworthy you really are.
Needless to say, the lower your credit score is, the fewer chances you have of getting a loan. However, you shouldn’t panic because there are many ways in which you can up your score. Since we are talking about general economic factors, they can be twisted and bent in such a way as to give you more appeal in the eyes of your lenders. If you do not know how to up your credit score, you can always discuss your situation with a private financial consultant. He or she will be able to guide you through all the steps you need to take.
Here are some examples of unsecured loans.
- Personal signature loans
- Credit cards
- Personal lines of credit
- A part of the Home Improvement Loans
- Student Loans – with the mention that you can garnish all tax returns so as to repay any delinquent student loans you might have on your record.
The answer to the question what is a secured loan is not tricky at all. In fact, it’s reasonably straightforward. However, make sure to think twice before you jump in the boat. Any impossibility of making your payments will result in dire consequences for you.
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