Friday, 22 March 2019
Just about everyone will borrow money at some time during their life.
When you do borrow money, it's important to have a clear understanding of the different types of loans available, how much they cost, and which one is right for you.
One of the most basic differences between types of loans is secured or unsecured.
What is a secured loan?
Secured loans are guaranteed, or secured, by an asset or collateral. Some of the most common secured loans are mortgages and auto loans. The mortgage loan would be secured by the house it is used to purchase, and the auto loan secured by the vehicle.
To lenders, loans guaranteed by assets are less risky because if the borrower defaults — or doesn't make loan payments — the bank can seize the asset and recover some money through the sale of the asset.
When items are used to secure loans, such as houses or cars, the lender keeps the title or deed to the item until the principal, interest, and fees are paid in full. At that time the title or deed is signed over to the borrower, who will own the asset outright.
Because there is less risk for the bank or lender, secured loans typically have lower interest rates, higher borrowing limits, and the terms are typically longer than with unsecured loans.
What can be used as collateral?
As mentioned previously, collateral is an asset used to secure a loan. Homes, cars, and real estate are some of the most common items used to secure loans. Other assets such as bonds, stocks, investment accounts, and valuable personal property can also be used.
Other examples of secured loans
A good credit score and proven income stream are important to qualify for any kind of loan; however, because a secured loan is guaranteed by an asset, it can be slightly easier to qualify for a secured loan than an unsecured loan.
Unsecured loans are not secured by an asset and are basically the opposite of a secured loan. Primarily known as personal loans, they are also referred to as "signature loans" because they are guaranteed by the borrower's signature.
In most cases, the borrower simply signs a loan agreement, thus promising to pay back the amount of the loan plus interest in monthly installments specified in the agreement. Once the paperwork is complete, the borrower receives the money.
Unsecured or personal loans can be used for anything, and can be any amount. Many banks and lenders make personal loans up to $100,000. However, typically collateral is required to borrow amounts over that.
If you have good credit, a personal loan can be an easy way to fund a purchase, home improvements, or a vacation. They can be used to pay taxes, college tuition, consolidate debt, or just about anything else.
However, because they aren't guaranteed by an asset, interest rates on unsecured loans are usually higher than secured loans.
Personal loans or lines of credit, credit cards, and student loans are all examples of unsecured loans.
Personal loans aren't for everyone. Credit score requirements are generally higher for unsecured loans than secured loans. Keep in mind that lenders who will loan to people with low credit scores aren't doing them any favors. If the borrower is unable to repay, the high interest rates and penalties may lead to a financially desperate situation.
If you have questions about what may be right for your situation, it's always a good idea to meet with a banker, loan specialist, or trusted financial advisor.
The content provided is for informational purposes only. Neither BBVA Compass, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial advisor about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA Compass or any of its affiliates.
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