Taking out a loan is a big financial commitment. By doing so, you’re essentially agreeing to give up a portion of your paycheck until the loan is paid off.
In case you’re wondering, an unsecured loan is a loan in which you don’t have to give the lender rights to a specific asset if you’re unable to repay the loan. This type of loan is generally taken out for home improvements, student loans, or personal loans. If you default on the loan, there’s nothing the creditor can take back to recover their loss of payment. With no protection if you default, interest rates are generally higher. Interest rates can range anywhere from 10–12%, and in some situations, are required to be repaid within two years.
On the other hand, a secured loan is a loan that’s used when borrowing a significantly larger sum of money. When taking out a secured loan, the borrower must provide some sort of collateral to ensure repayment. A secured loan is taken out for purchases such as a new car or home equity.
If you decide a secured loan is for you, what type of collateral must you provide? Depending on the terms of the agreement, it could be something as large as your home or your car. Secured loans generally offer lower rates, a higher borrowing limit and longer repayment terms due to the large sum of money that’s borrowed.
While you’re offering something up as collateral, that doesn’t necessarily mean you’ll lose your collateral for missing a payment or two. For example, if you take out a home equity loan, your home is your collateral. However, if you miss out on a payment, the lender is more likely to send you a letter requesting that you make your payment rather than take over possession. In the long run, it’ll take too much work and time for the lender to take over possession of your collateral for only missing a few payments. (Note: Just so we’re clear, I’m in no way suggesting it’s OK for you to blow off your payments every once in a while. Keeping up to date is much better in the long run.)
Now that we know what unsecured and secured loans are, how can debt from each affect you? A small portion (about 10%) of your credit score is based on the type of debt you carry and whether or not you have a variety of credit types. Revolving credit, or credit that’s automatically renewed as debts are paid off, and installment loans are also taken into consideration. The better you are at paying off your debts on time, the better off your credit score will be in the long run.
As you can see, unsecured and secured loans are used for very different purposes. Most people only take out a small amount of secured loans due to the amount of money they have invested in them. Unsecured loans are much more common because they’re much easier to obtain.
In what situations have you sought a secured or unsecured loan? Let us know in the comments section below!
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.