All Financial Institutes provide two types of loans: secured or unsecured.
If you’re considering taking out a loan now that the economy is on the upturn but are unsure what the difference between a secured or an unsecured loan, this article will help you get clarity.
Both of these loans are offered by all financial institutions and have their respective benefits.
Secured loans
Secured loans are loans that are backed by an asset as collateral. You are required to offer an asset as collateral to the lending agency. The cost of the asset should be proportional to the loan amount being taken. If you cannot repay the loan, the asset may be foreclosed by the lender. The lender may then choose to sell the assets to make up for the loan amount through the proceeds of your assets’ sale.
You can provide your property, car or stocks, equity, bonds, and other securities as collaterals for your loan. Assets like electronic gadgets, bank savings accounts, etc., cannot be kept as collaterals.
These assets are kept as a security by the borrower to hedge against future risks if the borrower cannot pay the loan and defaults on it. There are several types of secured loans, including mortgages, home equity loans, and auto loans.
There are several benefits of secured loans. Secured loans have a lower rate of interest because you are providing the lender with collateral. Additionally, the lender may provide you with a higher borrowing limit because you have kept your assets as collateral. However, if you choose not to get a higher amount, you can instead ask for a longer repayment period.
Unsecured loans
Unsecured loans do not require you to offer any security to the lender. Unsecured loans are the exact opposite of secured loans, and the borrower need not provide any collateral, security or asset as a token. Unsecured loans include education/student loans, credit card loans, and personal loans.
However, to be eligible for this type of loan, you must have a good credit score. A lender offers unsecured loans based on your credit score, annual income, and capacity. The lender ascertains your ability to repay the loan based on their bank account details, properties and other assets.
Credit score, credit history and income tax returns are three major aspects that a lender considers before looking at your application for an unsecured loan.
What happens if you cannot pay?
If you delay your monthly payment by 30 days or more, this will change your credit score. Banking and other financial institutions check credit scores for seven financial years. Therefore this change in credit score will likely affect your future loan prospects.
Additionally, if you default several times throughout the tenure, the bank may take legal actions to recover the amount.
Therefore an unsecured loan is a greater risk to the lender since they do not have any assets to recover the amount loan. As a result, unsecured loans generally have a higher interest rate, lower borrowing limit, and shorter tenure.
Which one should you choose?
As seen above, there are advantages to both these types of loans. Secured loans will provide you with a higher borrowing limit with lower interest rates. However, in the current situation where the finances are already strained, secured loans may add to your worry. If you have a good credit score, you can apply for unsecured loans.
