When you borrow money, you have the option of taking out a secured loan or an unsecured loan. While both types of loans will give you access to the cash that you need, there are different criteria used when screening a borrower’s application. There may also be different consequences if the loan is not repaid. What are some specific differences between a secured and unsecured loan that you need to know about?
Secured Loans Include Collateral
If you decide to go with a secured loan, you will be asked to provide collateral that the lender will keep if the loan is not repaid. In some cases, the collateral is the asset that has been purchased. This is true when you finance a car purchase, get a mortgage or buy a piece of equipment for your business.
However, collateral may also be used to secure loans that may otherwise have been unsecured. For instance, a credit card is usually an unsecured debt. However, a lender may require borrowers with poor credit to put money down that is kept until those borrowers make a certain number of payments. That money may also be kept if the credit card is not paid off.
Collateral may also be used to secure a personal loan to get a better interest rate or to improve the chances of being approved for the loan. Collateral could come in the form of a car, a house or other personal or business assets that are valuable enough to be worth liquidating by the lender.
What Are the Characteristics of a Secured Loan?
A secured loan often has a lower interest rate relative to the borrower’s credit score compared to an unsecured loan. In other words, borrowers with poor credit or no credit may pay less in interest than they would have if the collateral didn’t exist. In general the credit requirements are lower as well as people with subprime or close to subprime credit scores may qualify.
Secured loans may be preferable to lenders because the collateral can either be repossessed to be sold again or simply liquidated if necessary. In some cases, loans may be secured by accounts receivable or other assets that a borrower can count on receiving or otherwise using to pay the loan back.
What Is An Unsecured Loan?
An unsecured loan is a loan that is secured by nothing other than the promise of the borrower to repay it. Credit cards are usually unsecured loans as well as personal loans or personal loans used for business purposes. Since many unsecured debts may be eliminated in bankruptcy or otherwise hard to collect outside of going to court, borrowers generally need a credit score of 640 or higher to get the best rates or other terms.
What Are the Characteristics of an Unsecured Loan?
An unsecured loan generally comes at a higher interest rate even if the borrower has good credit. For instance, credit cards or similar lines of credit can have interest rates of up to 29.99 percent. Unsecured loans are generally revolving lines of credit that are offered by most banks, credit unions and other financial institutions.
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