Secured vs Unsecured Loans: What’s The Difference?
When you borrow money from a bank or other lending institution, regardless of what it’s for, it will be either a “secured loan” or an “unsecured loan”. The difference between how each type of loan works can have a big impact on the terms of the loan, the rate, and the consequences if you fail to repay the loan.
What Is A Secured Loan?
A secured loan is a loan that is backed by an asset, like your car, home, or other property you own. The terms of a secured loan mean that, if you fail to repay the loan, the lender can take the asset(s) specified in the loan in place of the money you owe.
The asset you agree to put up in exchange for a secured loan is the collateral. It’s very important to understand that even if a lender takes your collateral, you may still owe them money. If you borrow $20,000 and put your car up as collateral, the lender will repossess and sell your car if you don’t pay the money back. If the lender only gets $15,000 for your car, you will still owe them $5,000.
What Is An Unsecured Loan?
An unsecured loan is a loan in which no collateral is required. When you get the loan, you legally promise to pay the lender back the money you borrowed, plus any interest specified in the terms of the loan. Credit cards and student loans are two of the most common types of unsecured loans that most people are familiar with.
If you fail to repay an unsecured loan, the lender cannot automatically take an asset you own to compensate them for their loss. The lender will, however, report your failure to pay to the major credit ratings agencies and you will likely end up with a poor credit score.
Which Is Better?
Neither option is better than the other by default. Each type of loan has its uses in particular situations and you should evaluate any offer carefully before accepting.
Generally speaking, loans for larger amounts of money are secured loans, because lenders want to make sure they’ll be able to recover as much of their money as possible if you fail to repay the loan. Additionally, people with bad credit history are often required to put up collateral even for small loans, which can be a challenge.
Getting Out Of Debt
If you are struggling to repay either an unsecured or secured loan, and want professional advice, talking with an experienced financial planner can be helpful.
A financial planner can help you create a budget and personal balance sheet that will guide your purchases and debt management. Call us today or schedule a free financial planning consultation to learn more.
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