There is always a debate raging about which is better an secured or a unsecured loan so here are some facts about these two types of loans and the difference between them.
About Secured Loans
A secured loan is one where the borrower places an asset as collateral; this asset can be a car like in case of an auto loan or a mortgage on a house, so this type of loan is secured and involves very little risk for the lender. If the borrower defaults on the loan the lender has the right to repossess the collateral and sell it to recover the loan; for instance, foreclosures of a home. Secured loans present a higher risk factor for the borrower. The different types of secured loan include:
- A nonrecourse loan
- A mortgage
- An auto loan
About Unsecured Loans
An unsecured loan is the exact opposite of a secured loan; there is no collateral in this case which means that the lender is at a higher risk. If the borrower defaults on an unsecured loan, the lender can do very little besides reporting the late payment or default to the credit bureaus. However, there is no recourse for the lender to recover the loan in case of unsecured debts. Because there is no collateral that can be repossessed the borrower has a significantly lower risk factor.
The different types of unsecured loans include:
- Personal Loans
- Business loans
- Business loan with a personal guarantee
The Difference Between Secured and Unsecured Loans
Apart from the primary difference that is the presence of a collateral asset in case of secured loans as opposed to the absence of an asset in case of unsecured loans; there are three other major differences in these two types of loans.
- Borrower’s risk level: The borrower is at a considerably higher risk in case of secured loans because if the loan cannot be completely recovered through the amount received from the sale of the asset, the borrower will be responsible for paying the difference. So if a person fails to repay a secured loan he/she may not only lose the asset but will also be liable to make additional payments.
- Credit Checks: People often choose secured loans because their credit history is not good enough to get an unsecured loan. Because the lender has the right to repossess goods in the event the borrower does not repay the secured loan, there is minimal risk involved so even though the lenders will make it a point to check a person’s credit rating; they do not attach special importance to it in case of secured debts. As opposed to this, you will need to have a near pristine credit history to get an unsecured loan; any late payments or defaults will reflect badly on your credit rating and make you a high risk candidate. Since the lending institutions are already bearing a huge risk by offering loans without collateral they expect borrowers to have a very high credit rating.
- Difference in Terms and Interest Rates: The terms of secured and unsecured loans vary significantly. Generally, borrowers enjoy more favorable terms and lower interest rates with secured loans. Many lenders will also let borrowers extend the repayment duration in case of secured loans up to 30 years, while the terms of unsecured loans are very rigid.