A loan can be said to be money borrowed from a bank or an individual with a promise to pay it back. Loans can be backed by assets (secured) or not (unsecured) which forms the basis of the difference between secured and unsecured loans.
Secured loans
This are loans where the lender requires the borrower to provide asset such as, car, house or land to act as collateral for the loan. Collaterals act as guarantee to the lender in that they retain full right to repossess the assets in case the borrower fails to pay back the loan as agreed.
In some instances, the borrower is forced to pay extra money in order to service the full value of the loan in case the property’s market price is not equal to the total accrued loan amount.
Unsecured Loans
For the unsecured loans, the lender is not obliged to repossess your property in case of loan default. They are the type of loans that are given to individuals with good credit history. Most forms of unsecured loans are either personal loans or students loans. However, despite the loan being risk-free, the amount given out to borrowers is smaller compared to secured loans due to the risk involved.
In case of default or late loan repayments, the lender can report the borrower of either secured or unsecured loans to the credit reference bureaus. Information given to the to the bureau helps other lenders analyze the borrowers’ credit history.
If the borrower defaults to repay back the secured loan, the lender might use the foreclosure or repossession so as to recover the money defaulted thus, leading to poor credit score.
Advantages of Secured Loans
Despite the high risk involved in borrowing secured loans, many borrowers still have a high appetite for secured loans compared to the unsecured loans. But what could be the reason? The research has shown that most borrowers who seek secured loans do so due to their poor credit history.
When the borrowers set aside an asset to act as the security, the lender becomes more lenient and they lend out the money because there is collateral given which reduces their risk.
On the other hand, secured loans have higher loan limits compared to unsecured. It is very important that the borrower becomes fully aware of the terms and conditions governing the loans such as interest rates, repayment periods and monthly payment amounts prior to signing the loan agreement.
It is also equally important to note that some lenders dealing with mortgage or auto-loans cannot approve your loan application until you provide collateral to act as loan security. Title and pawn loans are examples of secured loans which are design secured.