Secured and Unsecured Loans

Secured and Unsecured Loans
Secured and Unsecured Loans are the two basic kinds of loans. Secured Loans are loans backed by collateral pledged by the borrower. Unsecured Loans are loans with no collateral. They are issued solely on the creditworthiness of the borrower.

What is a Secured Loan?

A secured loan is a type of loan that is “secured” by collateral. The borrower posts an asset, and the lender reserves the right to seize the asset if the loan is not repaid.

How does a Secured Loan work?

With a secured loan, the borrower offers an asset – called “collateral”—that the lender can seize in the event of a default. Any loan that involves collateral is considered a secured loan. Some common types include home mortgages and auto loans, as well as predatory ones like title loans and pawnshop loans.

Why use Secured Loans?

One benefit of secured loans is that they typically come with lower interest rates than unsecured loans. Borrowers post collateral, so the loans are less risky for lenders. This means that they can offer lower annual percentage rates (APRs) as well as extend loans to borrowers who otherwise might not qualify.

Are Secured Loans easier to get than unsecured loans?

Secured loans are one way that borrowers with bad credit can increase the likelihood that they’ll qualify for the loan they want. By offering collateral, borrowers are less of a financial risk to lenders, and this means that secured loans are easier to get – even for borrowers who have good credit but want to make a big purchase like a home or a car.

Are Secured Loans a good idea?

Secured loans offer benefits, but they also come with risks, as borrowers post collateral that lenders can seize in the event of default. Title loans—one type of secured loan linked to predatory practices—are notoriously risky for borrowers. Unlike other secured loans they have high APRs, and to receive them borrowers sign over the title to their vehicle. If the borrower fails to repay the loan, the lender is legally entitled to seize the car and sell it to recoup the amount the borrower owes.1

Secured loans like mortgages and auto loans are common and can be a good idea if they allow borrowers to receive lower interest rates or qualify for loans they otherwise might not receive. However, like all loans, borrowers should be certain they will actually be able to pay back the money they borrow. Missed payments and defaults can have a big impact on credit, and with secured loans, a borrower’s collateral can be seized as well.

Can a Secured Loan boost my credit?

A secured loan itself will not boost a borrower’s credit. However, borrowers may be able to improve their credit by making on-time payments—if the lender reports payments to credit bureaus. The advantage of secured loans is that borrowers&mdasheven those with bad credit—are more likely to get approved for a loan. This gives them a chance to build their credit by making on-time payments. However, if they enter delinquency or default, their credit will suffer.

Where can I get a Secured Loan?

Secured loans come in many forms and are offered through a number of different kinds of lenders. Banks and credit unions are a source for mortgages. Title loans are offered by title lenders, but these loans are widely considered predatory and come with high APRs and short terms. Pawnshop loans are offered by pawnshops, but they also have high APRs and short terms, and if borrowers fail to make payments, they lose their collateral.2

What is an Unsecured Loan?

An unsecured loan is a type of loan that doesn’t require the borrower to post collateral. The loan is considered “unsecured” because there is no asset that the lender can seize in the event of default.

How do Unsecured Loans work?

When a borrower applies for an unsecured loan, the lender will review the borrower’s credit history and credit score. As there is no collateral, the loan amount – and whether the lender approves a loan at all – is largely based on the borrower’s creditworthiness. Creditworthiness also impacts the interest the lender charges, with better rates offered to borrowers with better credit histories.

Lenders consider unsecured loans risky, as they are less likely to recoup their money if borrowers default. But while there is no collateral to claim, borrowers are nonetheless still responsible for the debt they owe. If they default, lenders can take them to court or sell their debt to a collections agency. Among other things, a judge can issue an execution order, which allows the lender to garnish up to 25 percent of a borrower’s wages to repay the loan.3

What are the different types of Unsecured Loans?

Any loan that doesn’t require collateral is considered an unsecured loan. Some common types of unsecured loans are personal loans, student loans, cash advances, and lines of credit. A credit card is also a form of unsecured loan, as the cardholder makes purchases on credit and provides no collateral to guarantee that the balance will be paid.

Are Unsecured Loans safe?

Most unsecured loans are safe if used responsibly. However, payday loans are one notorious type of unsecured loan that are considered predatory due to unreasonable rates, terms, and practices. Payday lenders operate in storefronts and online. They provide loans without checking borrowers’ credit history to ensure they can pay it. Though not all unsecured loans are necessarily risky, payday loans come with astronomical interest rates and unrealistic repayment terms, and should be avoided.

How much do Unsecured Loans cost?

Because unsecured loans are a greater risk for lenders, they are almost always more expensive than comparable secured loans. With unsecured loans, borrowers are primarily evaluated based on creditworthiness. Those with a high credit score will pay less in interest rates, while borrowers with low credit scores will have to pay more.

How much can I borrow with an Unsecured Loan?

For high-value loans like home mortgages, lenders almost always require some form of collateral. They are reluctant to offer large loans without assets to ensure that they’ll receive their money back.

With unsecured loans, the amount that someone can borrow is usually limited. On the high end, borrowers with excellent credit can qualify for personal loans of up to $100,000.4 Because lenders assess creditworthiness, borrowers with an excellent credit score will be able to borrow more than those with poor credit.

Where can I get an Unsecured Loan?

Unsecured loans come in many different forms and are offered by many different kinds of lenders. Student loans are offered by private lenders and the federal government. Credit cards are offered through credit card companies. With personal loans, some reputable lending sources that offer unsecured loans are banks, credit unions, and responsible online lenders. Payday loans are another type of unsecured personal loan, but they are tied to predatory practices. Some things to watch for when considering an unsecured personal loan are a low APR, a minimum 90-day term, and equal installment payments.

References:

  1. “Signs of a Predatory Car Title Loan.” Center for Responsible Lending. Retrieved on January 23rd, 2017 from http://www.responsiblelending.org/other-consumer-loans/car-title-loans/tools-resources/signs-of-a-predatory-car-title-loan.pdf.
  2. Lee, J. “The Truth About Payday, Pawnshop and Car Title Loans.” U.S. News. Retrieved on January 23rd, 2017 from http://money.usnews.com/money/blogs/my-money/2014/05/22/the-truth-about-payday-pawnshop-and-car-title-loans.
  3. Krulick, A. “Defaulting on Your Loans.” Debt.org. Retrieved on January 23rd, 2017 from https://www.debt.org/credit/loans/default/.
  4. Latham, S. “Best Unsecured Personal Loans for 2017.” The Simple Dollar. Retrieved on January 23rd, 2017 from http://www.thesimpledollar.com/best-unsecured-loans/.