Loans are never a fun topic of discussion but most of us at one point in time will have to obtain a loan. Many lenders offer both secured and unsecured loans. Aside from the obvious difference of a loan being collateralized or not, there are still many characteristics that set these two loans apart.
One of the most important steps before thinking about obtaining any type of loan is to make sure you've done everything you can to improve your credit score. Try to plan out three to four months in advance to take a look at your credit report and find rooms of improvement. Whether it's paying off a small collection account or reducing your overall debt loan by a few percent, the simplest action may make or break your loan application.
The Main Difference Between a Secured and Unsecured Loan
Secured loans are collateralized by an asset, such as a car or home. The most common type of secured loans are mortgages, HELOCs, and auto loans. These types of loans carry less risk for the lender since the lender technically still owns your asset.
On the flip side, examples of unsecured loans include credit cards, personal & business loans, and even dreaded payday loans. These types of loans have a higher risk which means your interest rates will typically be higher.
The Benefits of a Secured Loan
The biggest benefit of a secured loan will allow you to get a loan you may not otherwise qualify for. Lenders will feel more comfortable knowing they have some type of protection in case you default on a loan. For example, if you default on your mortgage the lender can start foreclosure proceedings and auto lenders can repossess your car.
Although your credit score will play an important role on whether you get a loan or not, it's not the single biggest factor when getting a secured loan. For example, you might not be able to get a loan with a 630 credit score but you may be able to qualify for a mortgage with the same score. On the other hand, if you have a track record of collection accounts and bankrupties, this will be a different story.
The other benefit of a secured loan is that your loan value can be greater than an unsecured loan. If you're shopping for a personal loan and need $10,000 but you're only approved for $5,000, the lender may increase this limit depending the asset you can put up. Now of course this is generally a case by case scenario with each lender, but you'll be surprised at the loan limits you may be able to get.
The Benefits of an Unsecured Loan
The biggest benefit of an unsecured loan is that you don't have to have a collateral to get a loan. For example, not everyone chooses to own a car or a home- so if a lender is requiring you to put up an asset to get a loan, you'll be out of luck.
There's also the ease of getting an unsecured loan as well. Since unsecured loans come in to many different shapes and forms, you'll have a wide array of options to choose from. The application process for most of these loans are also super quick and fast.
Because unsecured loans can be processed faster, it allows you to get the quick cash when you need it. Whether you want to consolidate debt, pay for a wedding, or have a medical emergency, unsecured loans are a great way to cover these expenses. Generally speaking, you can use unsecured loans for whatever purpose you want.
Now of course there several downsides with getting an unsecured loan. The biggest downside is the interest rate it carries. Since lenders carry more risk, they will understandably charge a higher interest rate. Depending on what type of loan you obtain, the type of interest charged will vary. For example, most credit card issuers will take your daily average balance and charge interest based on that versus your closing statement balance. Most personal loans will amortize your loan similar to how mortgages are paid.