Borrowers are often offered different types of loans, such as personal loans, cash loans, payday loans, business loans, etc. In general, all loans are distinguished as secured and unsecured. Here is what you need to know about the difference between these loans and the ones you should go for.
What is a secured loan?
As the name suggests, a secured loan is secured by something that can replace payment in the event of default by the borrower. This substitute is called “collateral”. The collateral can be your house, car or other things that are dear to you, the amount of which can cover the loan you have borrowed. Banks usually ask for collateral when the loan is too large. Since borrowers inevitably default, banks use collateral to cover the loan amount.
For example, if a house is used as collateral and the borrower is unable to repay the loan, the bank has the right to seize the property and sell it. Once foreclosure begins, the borrower must relinquish their ownership interest in the property.
Benefits of a secured loan
- Approval of secured loan application
The first advantage of applying for a secured loan is the secured approval. Who wouldn’t want a loan application with quick approvals? Banks and other lending institutions tend to approve borrowers if they can present collateral for the amount of the loan sought. If you have a property like a house or a car and you need the cash right away, you can easily get what you need by pledging your property. If you intend to repay the loan regularly, you don’t have to worry about foreclosing on your collateral. So, remember to pay your loans on time periodically.
- No need for a guarantor
Since the collateral serves as a backup, you don’t need to present a guarantor or co-borrower in most cases. Banks and credit institutions accept guarantees as the only safeguard as long as they meet the criteria they have defined.
- You will be encouraged to repay your loan in full
Finally, with a secured loan, you will be encouraged to repay your loan in full. Your property is pledged and there is a risk that the lender will seize it if you do not pay. That’s enough encouragement to get you to pay on time if you don’t want your assets to be wasted.
Disadvantages of a secured loan
- You must abandon your property in the event of default
While a secured loan offers some benefits, it also comes with a risk. The first risk you need to take is the idea that you might have to give up your property in case you can’t pay the loan anymore. This is the very reason why loans have collateral. If the borrower can no longer pay, the lenders will use the collateral to pay off the loan. It is a big risk for borrowers.
- The fair value of your collateral must be greater than the amount of your loan.
Another downside is the fact that your collateral must meet the standards set by banks and credit institutions. The fair value of your collateral is essential in this type of loan.
In most cases, lenders determine fair value based on market prices. They do the assessment as part of the process. If your property does not meet the criteria or standards, you may need to provide another property to pledge. Otherwise, your request will be rejected.
- If you have no property to pledge, your loan application will be rejected.
If you don’t have a property to secure as collateral when you apply for a secured loan, then this loan is not the right one for you.
What is an unsecured loan?
An unsecured loan is the type of loan that does not need collateral. As the name suggests, it is unsecured, meaning that the bank or lender has no property to seize if the borrower defaults. Unsecured loans are useful for people who do not own properties or do not want to pledge their assets. It is also a good option for those who need cash immediately.
Benefits of unsecured loans
- It is not necessary to involve your assets
The first reason why unsecured loans are good alternatives for borrowers is the fact that no assets are needed to get a loan. This means that whether or not you own a home, you can apply for loans as long as you qualify and have all the necessary documents.
- High credit scores and good credit records are often enough
Unsecured loans are also favorable to those with high credit scores and good credit records. Most often, the credit scores are enough to qualify you for unsecured loans. For example, if you are applying for a cash loan, you don’t need to provide a lot of documents if you have a high credit score. It’s easy to get approval if your records are good.
- Easy application process
Since unsecured loans don’t need collateral, you don’t have to go through the appraisal process and wait for the lender to determine the fair value of your property. For borrowers, this means an easier application process. All you need to do is submit your documents and wait for approval.
- Immediate cash for qualified borrowers
Unsecured loans are also intended for those who need immediate cash. You no longer have to look for collateral if you are qualified. Prepare your documents, show your credit scores to your potential lender, and get your loan approved quickly. For those who are looking for short term loans, unsecured loans are ideal.
Disadvantages of unsecured loans
- High interest rates
Since the loan is unsecured, banks and lending institutions impose high fees and penalties on those who violate the terms and conditions. Although you can get the loan right away, you will have to pay high interest rates later on. Some borrowers can tolerate this inconvenience, but it is costly.
- Bad credit records if you default
If you don’t pay on time or if you default, the lender will have to report it, which means your credit records may be affected. Plus, bad credit will affect your future loan applications. So if you want to avoid this, you need to plan your payment timely and wisely.
- Strict loan conditions
Finally, banks and other lenders are strict about enforcement. If you do not meet one or two conditions, your application will be immediately rejected. That is why it is essential to submit your complete documents on time. Although the bank will follow the necessary details in an incomplete document submitted, they may put your request on hold for review at a later stage.
How to choose between secured and unsecured loans?
The answer depends on what you are looking for and the purpose of the money you want to borrow.
For borrowers with a large loan amount
Secured loans are best for long term borrowers and those who need a large amount of money. If you are borrowing to pay for your children’s school fees, renovating your home, buying another property, or other expensive things, secured loans are suitable. This type of loan has a low rate of interest. Even if your payment plan takes a year or more, you won’t be paying big on the interest.
For short-term borrowers
For borrowers who will be using the money for monthly expenses, medical bills, or other short-term expenses, unsecured loans are preferable. However, remember that you have to pay high interest rates. This is the risk that you have to take when you borrow unsecured loans. If you also don’t have any properties to put as collateral, unsecured loans will be your only choice.
The type of loan that you can get will depend on many factors. You should also consider the requirements. If you think that you are not qualified for secured loans, try to apply for unsecured loans. If you need the cash right away and want secured approval, then secured loans might be a better choice.