Listen, have you ever wondered what the main distinctions between secured and unsecured loans are? If you need to leverage a loan, knowing the difference between secured and unsecured debt can help you position yourself to make wise financial decisions.
Then people take out loans for a number of reasons, and loans are a type of debt. For example, you might get a loan to buy a house or a car. For your education, you may also take out student loans. Those who are coping with health concerns frequently borrow money for medical expenses.
But, not all loan debt is created equal, and if handled carelessly, it might become extremely costly or even result in bankruptcy. How do secured and unsecured loans differ from one another, and how do they impact your finances?
So that you can comprehend the variations between secured and unsecured debt/loans, let’s go into the essential elements.
What does a secured loan mean?
A secured loan can be defined as a type of debt that is backed by an asset that acts as collateral. Basically, the lender, also known as the lienholder, can seize the associated collateral and use it to pay your debt if you fall behind on your payments.
And secured loans are typically less risky for lenders. This is because they have assets associated with the debt. As a result, interest rates for secured loans are typically lower than unsecured debt.
Also the difference between secured and unsecured loans is that an unsecured loan does not require collateral, and a secured loan does.
Examples of Secured Loans
Here are some secured loan examples so you can better see the difference between secured and unsecured loans:
1. Mortgage loans
One of the most popular secured loan examples is a mortgage loan. Mortgages are tied to an asset, for instance, a residential or commercial piece of real estate. Typically, you take out a mortgage on a property with predetermined monthly payments.
If you default on your payments, your lender will send you past due notices. If this goes on for an extended time period, they might begin foreclosure proceedings to repossess the asset.
They will then attempt to sell the property to cover the debt you owe. However, if the sale of the asset does not cover the debt in its entirety, you may be liable for the difference.
2. Auto loans
Next up on the secure loan examples list are auto loans. Remember, you don’t really own the asset (your car) outright until you pay the debt in full. So, if you don’t make your payments, your lender will repossess the vehicle.
Therefore the car is the asset you are borrowing against, and if you don’t pay, you can lose it. That’s why it’s essential to purchase a vehicle you can afford and get into a cheaper rate so you can save money.
3. Secured credit cards
Now that we’ve talked about secured loans, you might also be wondering about secured credit cards. A secured credit card is a type of card that requires a security deposit. This deposit can be as low as $200 and is usually equal to your desired credit limit.
The credit card issuer holds onto your deposit in case you default on your payments. You can use a secured credit card if you need to improve your credit score and history. If you default on the loan, then they use your deposit to pay off the debt.
Definition of an unsecured loan?
Of course on the other hand, an unsecured loan or unsecured debt is a type of debt that is not tied to any asset as collateral.
As a result, these loan types are risker for lenders and typically come with higher interest rates. This is why a mortgage interest rate can be 5%, and a credit card’s interest rate can be 20%.
Although they can’t repossess an asset, it can still have a negative impact on your finances if you default on your payments.
The Unsecured loan examples
Below are some common unsecured loan examples. Remember, when comparing secured vs unsecured loans, the interest rate for an unsecured loan is usually much higher. Again, this is because this type of loan is much riskier to the lender.
Personal loans
Personal loans are one of the unsecured loan examples you are probably familiar with. You can use personal loans to consolidate credit card debt, student loan debt, and medical bills.
Sometimes people use them for starting a business or things such as auto repairs, etc. However, they typically come with a higher interest rate than a secured loan does.
Credit cards
Again, credit cards can be secured and unsecured loans. An unsecured credit card does not require a security deposit. Your line of credit is based on your credit score, history, and income.
Although you see promotions for 0% interest, it’s still essential to pay these off every month because once the promo is over, the rate can skyrocket to an amount you are unable to afford.
Student loans
Student loans are another example of unsecured loans. No matter what type of student loan you take on, it can get costly.
In fact, the average federal student loan debt is $36,510. Private student loan debt comes with an average and hefty price tag of $54,921 per borrower.
Also, lenders can capitalize on the interest, which can create a cycle of debt that is hard to dig out of. So, before applying for student loans, try to find alternatives to fund your education to cut costs.
So now you know the difference between secured and unsecured loans, let’s dig into how they affect your credit.
The secured vs unsecured loans: Credit reporting
When comparing secured vs unsecured debt, keep in mind that both can have a huge impact on your finances. Failing to pay any debt can result in late fees, penalties, and negative remarks on your credit.
If you default on a secured loan, you will lose whatever asset that was securing the loan. An unpaid unsecured loan will go to collections. With debt like back owed child support, it can result in jail time by court order.
All of these actions can hurt your credit score, making it hard for you to secure good loan terms in the future. It may also impact your ability to even get a loan or any form of credit at all. Yup, this includes actions taken by child support enforcement agencies about unpaid child support.
When using secured vs unsecured loans
Don’t forget that you want to make sure you are being deliberate while using secured and unsecured loans. It’s critical to understand the potential costs of each loan type in terms of the collateral needed and the interest rate charged. Searching around for the finest loan rates and offers will help you do this.
Also, you should watch out for borrowing more money than you can reasonably afford or need. Before you think about using debt as leverage, it’s a good idea to evaluate how much money you can save on your own.
The last thing you want, for instance, is for your property to be seized or repossessed because you were unable to repay a secured loan.
At the end of the day, debt comes at a cost, and that cost is in the form of interest. So it’s important to be cautious when it comes to leveraging debt.
However, be also noted you can save up for those big purchases instead of taking out a loan. Make saving fun and enroll in our completely free “savings challenge bundle.” It includes the 26-week savings challenge, the $5 savings challenge, and more
Leave a Reply