As a consumer, you must have a variety of options to choose from when you are looking to borrow a personal loan. However, there are only two categories – secured and unsecured. Read this blog to understand the difference that may help you to choose the right one. ⭐Read and Analyse⭐Major Differences
Borrow – the dictionary meaning of it is taking and using (money) from an individual or financial institution under an agreement to pay it back later. The creditor may charge you an interest rate that you have to repay along with the principal borrowed amount. You must have seen a wide range of loans on the internet such as – wedding loans, holiday loans, home improvement loans, auto loans, mortgage loans and many more. All these financial products fall into two categories, namely – secured loans and unsecured loans. A personal loan can be secured or unsecured as it depends on the lender or the financial institution you are dealing with. In this guide, we will cover:
- What is a secured loan?
- What is an unsecured loan?
- Major differences
- How to choose the right one?
What is a Secured Loan?
A secured loan, also known as a secured debt is a loan that is borrowed by an individual by pledging some asset as collateral. It means that you have to pledge any of your valuables such as your car, your home or property as collateral while borrowing a secured form of a loan. Such loans allow you to opt for larger amount of money and the course of repayment also continues for a longer duration. The concept of this loan is – if the borrower fails to meet the repayments, the lender may resale your collateral to recover the money that was lent to you. Moreover, the idea of losing your car or home is terrifying and that acts as an influential stimulus for you to repay the loan on time.
Different Types of Secured Loans
There are multiple forms of secured loans available in the financial services market. However, the majority of people often borrow 2 types of secured debts, which we have listed below:
Auto loan, generally known as a vehicle loan, is a type of personal loan that is borrowed by an individual to purchase a vehicle or automobile. The borrower has to repay the loan amount [principal and interest] to the lender usually in monthly instalments. The vehicle that the borrower purchases act as collateral in the borrowing process. If the borrower fails to repay the debt, the lender may repossess the vehicle and resale it to cover their loss. That means until the loan is completely paid off – the borrower doesn’t fully own the motor vehicle. The borrower will own the vehicle outright once they pay off the whole debt without any fail to the lender.
This loan is borrowed by individuals to buy a property or land and the loan is secured on the value of your home. Also, existing homeowners take out a mortgage loan to raise funds for other purposes by putting their home as security. In the event where the borrower fails to repay the loan, the lender can repossess the property and resale it to get their money back. The borrower is obliged to repay the loan along with the interest to clear off the debt that they have taken. These are also termed as “lien against property”.
Types of Collateral Used to Secure the Loan
Collateral is an asset that is pledged by the borrower to secure the repayment of the loan. It acts as a promise to the lender and if the borrower falls behind the repayments, the lender may repossess the asset and resale for their recovery. It is also known as asset-based lending.
- Real estate: It includes your home, property, and land.
- Vehicles: The car/bike/automobile you are purchasing, or you already own.
- Bonds: Stocks, mutual funds, investment accounts.
It may also include certificates of deposit accounts, cash or savings accounts, insurance policies, valuables such as fine art, jewellery and collectables. The type of collateral that you may offer depends on the type of secured loan you are considering to borrow and the lender as well.
What is an Unsecured Loan?
An unsecured loan is borrowed by an individual without pledging any asset as collateral. Rather the loan is backed by the borrower’s creditworthiness. These are often referred to as personal loans or signature loans. That means if you fail to make the repayments, none of your valuables can be repossessed by the lender. Therefore, there is no risk of any collateral damage. However, these loans are a lot riskier for the creditors as if the borrower defaults on the loan, they have to bear the loss. The credit score of the borrower will be at risk as failure to repay the loan on time and in full will knock off a few points from it.
Different Types of Unsecured Loans
There are 2 types of unsecured loans available – a revolving line of credit and instalment loans. An instalment loan can be categorized into two types, (i) Fixed-interest rate loan and (ii) Variable-interest rate loan. With a fixed-interest rate loan, the monthly repayment amount is fixed for each month. While, with a variable-interest-rate, the monthly repayment amount is not predictable as it may change according to the market and the lender. Various types of unsecured loans are listed below:
A credit card is a classic example of a revolving line of credit. A spending limit is fixed by the credit card company or the bank, which you can use to pay for your expenses. The repayment has to be done on a particular date that will be set by the financial institution, which is known as payment due date.
These are personal loans that couples or individuals often consider to borrow to cover the shortfall of their wedding expenses. The average wedding cost in the United Kingdom has reached £32,000. It is an unsecured form of borrowing and hence, couples find it a feasible option that helps them to plan their dream wedding.
Debt Consolidation Loans
A debt consolidation loan is borrowed to simplify your existing debts. People who struggle with multiple loans and find it extremely difficult to manage the repayments consider merging their debts into a single loan. Sometimes, it helps them in saving money as they have to pay only one loan instead of repaying 10 different loans.
|TERMS||SECURED LOANS||UNSECURED LOANS|
|Security||Your property, home or automobile is used as collateral. If you fail to repay the loan, the lender may repossess your valuables.||You do not have to put up any asset as collateral to apply for an unsecured loan.|
|Amount||Generally, large sums of the amount are offered. However, it also depends on the source you’re borrowing from, debt-income ratio, credit score, amount of equity of your property, your age.||The amount that you can borrow depends on your income, expenses, credit score, employment status, and several other factors. However, typically, lenders offer you to borrow an amount ranging from £1,000 to £35,000.|
|Interest Rate||The rate of interest that will be offered to you if you borrow a secured loan will be comparatively lower because of the collateral that you pledge.||These loans have a higher rate of interest as compared to secured loans.|
|Tenure||You can choose a 25-year term or a 40-year term. It completely depends on the amount that you’re borrowing and your repayment affordability.||Such loans can be taken out for a period of more than one year. You have to make the repayments of the loan within 12-84 months.|
How to Choose the Right Loan?
It is not difficult to determine what type of loan will suit you the best if you understand the difference between both the financial products. It also depends on your purpose of borrowing a loan, how much money you need to borrow and how long will it take you to repay the loan. Your credit score is also a deciding factor for the type of loan you select to go ahead with.
5 easy steps for choosing the right loan:
- Evaluate the amount that you need and for how long
- Calculate your debt-to-income ratio
- Calculate the overall cost of borrowing
- Consider your affordability
- Select a product that seems much less risky
Whether you choose a secured loan or an unsecured loan – you must focus on timely repayment as that it will help you to improve and maintain your credit score. Never borrow an amount that you cannot afford to repay as that may have serious consequences on your overall borrowing journey for the next 6 years. Opting for a loan can be considered as a smart alternative to credit cards as it offers lower interest rates and monthly instalments are predictable as well. Taking out a loan is a serious financial matter, and it requires a lot of planning and preparation. Consider the pros and cons of each of the product before making your final decision.