Understanding the Difference Between Secured and Unsecured Loans
Loans refer to an item, usually money, given by one party, the lender, to another party, the borrower for a period of time after which the loan is repaid with interest by the borrower to the lender. Loans could have several classifications. This article would however cover secured and unsecured loans.
Secured loans are loans that are given to the borrower on the strength or backing of an underlying asset which would serve as collateral for the loan.
Unsecured loans on the other hand are loans given without the requirement of an underlying collateral. These loans are often given based on the credibility, status or profile of the borrower. . The basic difference between the two is presence or otherwise of a collateral. The question now becomes what the difference between secured and unsecured loan is and which of them is available to you?
- Real Estate
- Movable Assets including vehicles
- Bank accounts/investment accounts
- Investments; stocks, mutual funds, bonds, etc.
- Valuable antiques/heirloom
Notably, while all the above can be used as collateral, only some lenders will accept all of them. Some lenders will specialize in one or two of the above collaterals, while another lender may be more accepting of the variety.
There are instances where your collateral does not have to be something you already own but what you intend to purchase with the loan. For example, a car loan or mortgage where the collateral is the purchased asset.
- Easier to qualify: Qualifying for a secured loan is easier if you have the right collateral. This is because the financier is able to mitigate the risk of default and there is a higher expectation that you will pay back
- Generally lower interest rates: Although interest rates depend on various factors but with a high-value collateral, a secured loan is likely to have lower interest rates.
- Higher loan limits: It is easier to negotiate a higher loan limit with a secured loan.
- Use of funds: Depending on how the loan is structured, there may be restrictions on how you can use the funds.
- Forfeiture of collateral: The penalty for defaulting can be severe as it may lead to forfeiture of the collateral to the lender, and can also damage your credit rating.
- There is no risk of forfeiture of collateral as seen in secured lending
- Quick Access to Funds: Unsecured loans are usually consummated quicker than secured loans, as the time taken to get collateral in place is eliminated.
- Amount Available: Depending on the general profile and credit rating of the borrower, the Lender may only be willing to lend a limited amount since there is no collateral backing for the loan.
- Limited financiers: Not all financiers will be willing to offer you a loan, especially if your trustworthiness cannot be verified
- Higher interest rate: Unlike loans with collateral, unsecured loans carry a larger risk of default for lenders, resulting in higher interest rates.