In general, loans can be divided into two broad categories: secured and unsecured. A secured loan is “secured” by an asset called collateral that the lender can seize if you do not repay the loan. In contrast, an unsecured loan does not require any collateral and is lent only on the basis of your creditworthiness and repayment capacity. Because there is no underlying asset securing the loan for the lender, these loans tend to carry significantly higher interest rates than secured loans. In this guide, we explore the difference between secured and unsecured loans in detail and discuss some innovative ways to use these types of loans.
Secured loans vs unsecured loans
There are a few major differences between a secured loan and an unsecured loan that are worth highlighting. First of all, the biggest difference between the two is what happens when you stop making payments or default on the loan. For secured loans, the lender has the right to seize the pledged asset (also known as collateral) from the borrower to recoup his loss without going to court. For example, home loans and auto loans are the most common types of secured loans, where your home or car serves as collateral, and you could lose your home or car if you default on your payment. mortgage or car loan. However, this is a rather dramatic result, and defaulting borrowers usually have the option of paying off their debt (with a few additional fees) without losing their assets. However, being late with your payments will hurt your credit rating.
On the other hand, you don’t have to pledge assets to secure an unsecured loan, so you don’t risk losing your assets if you don’t pay off your debt. However, defaulting on your unsecured loans comes with serious consequences as it can seriously ruin your credit score and prevent you from getting other loans or even credit cards in the future. The most famous examples of unsecured loan are personal loans and credit card.
The second big difference here is the interest rates. Since the lender has an asset to secure a secured loan, he is willing to provide the fund at a lower rate than unsecured loans. Therefore, the average interest rates for personal loans tend to be twice as high as the average mortgage interest rates.
Innovative applications of secured and unsecured loans
There are many ways to use these different types of loans in innovative ways when you need additional capital.
The first is a home equity loan. It is a type of secured loan that allows borrowers to secure a loan against the value of their home that has already been repaid. By pledging the equity in your home as collateral, you can get a secured loan up to 10% cheaper than your conventional personal loan. In fact, these loans tend to cost only a few basis points more than normal home loans.
Second, a refinance loan is ideal for people who have paid off part of their home or car loan, but still owe money on the original loan. In some cases, the borrower may take out a new loan for an amount greater than the original one. Therefore, if you need more money, you can use the new loan to pay off the original and use the remaining money.
Finally, you can sometimes secure your personal loan (which would otherwise be unsecured) with your savings account or certificate of deposit with the lender. This could help reduce the high interest rate that usually accompanies an unsecured personal loan. If your account is nearing maturity, however, you might want to wait a bit longer to use the money you’ve saved instead of getting the loan and ultimately incurring costs. additional interest payments.
Whether you get a secured loan or an unsecured loan, your ultimate goal should always be to minimize interest charges while borrowing the minimum amount you absolutely need. Loans can be expensive and not paying them back on time can have long term consequences that can negatively impact your life.
Moreover, if you are rejected for secured and unsecured loans, you should always avoid going to money lenders or use a payday loanbecause they have an astronomically high price. There are better alternatives if you really need the money. For example, even credit card debt is cheaper than a loan from a money lender. Not only that, pawn shop offer surprisingly low rates as long as you can pledge an asset that’s valuable enough to secure the amount of money you need.