To be a smart borrower, you need to understand the differences between each type of loan available to you. Two of the most common loan types are secured loans and unsecured loans. Here's what you need to know about each.
Understanding secured loans
When you take out a secured loan, you have to use something of value that you own, like your car, home, or other valuable personal property. This is called collateral. The lender holds the title or deed to the collateral or places a lien on the collateral until you pay the loan off in full. If you do not repay the loan in full, the lender has the right to take possession of the collateral and apply the proceeds of the sale of the collateral to the outstanding debt.
The borrowing limits for secured loans are typically higher than those for unsecured loans because of the presence of collateral. Mortgages and home equity lines of credit are two common types of secured loans. Secured loans can have either a fixed or variable interest rate and can last for a set or variable amount of time.
You may have a longer time to pay back a secured loan, in comparison with unsecured loans, and interest rates are frequently lower because the lender holds your collateral and faces less risk if you don't pay back the loan. The process of getting approval for a secured loan may take longer and require more paperwork.
How is an unsecured loan different?
An unsecured loan is money that you borrow without having to use something of value that you own as collateral. Most unsecured loans have a fixed term and a fixed interest rate. This means:
- you have a set amount of time to repay the loan
- the loan payment is the same each month
- the interest rate cannot change during the term of you loan
The approval process for an unsecured loan is usually quicker than for a secured loan because there is less paperwork. Also, there is usually a lower borrowing limit for this type of loan. Since you are not using anything of value, as with a secured loan, the lender faces a higher level of risk. Because of this, the interest rate for an unsecured loan is often higher than for a secured loan.
Know before you borrow
Both secured and unsecured loans can differ a good deal from one lender to the next. If you plan to apply for a loan, try to have a clear understanding of how your loan will work, what you'll have to pay each month over the life of the loan and what the lender is promising you in return. Before you make any borrowing decision, make sure you can afford to pay back your loan in a timely matter without straining your budget.
The information in this article is provided for education and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.