A secured loan, and borrowing money is as normal as every of our everyday financial activities. Individuals borrow, the same way as corporate bodies, as well as other formal/informal associations, seek financial assistance. Not forgetting governments across the world too. These borrowings are generally called loans. However, differences lie therein between a secured loan and an unsecured loan.
Whenever you are about to borrow money for your personal use or on behalf of a body, one of the decisions you will have to make either consciously or subconsciously is to choose between the secured loan and unsecured loan, which avenue shall service your financial needs.
The secured type of loan is one where you, as a borrower, get access to financial assistance after providing the lender with collateral. The collateral is assets that can be turned into cash by the lender in case the borrower is unable to pay back the borrowed money. These assets range from cars, landed properties and others that are considered valuable by both parties involved in the borrowing before the lender releases the money to the borrower. A typical example of a secured loan is a car loan or mortgage.
An unsecured loan, on the other hand, is a type of loan that is not covered by collateral. Unlike in the case of a secured loan where the lender can claim ownership of the collateral upon repayment default by the borrower, there is no collateral to take over by the lender if the borrower fails to pay back an unsecured loan. Products like credit accounts, student loans, and personal loans are typical examples of unsecured loans.
Unsecured loans are usually more popular, do not require collateral from the borrower, making the lender take more risk, and as a result, higher interest rates apply. Credit card loans, Student loans, Payday loans and Personal loans are popular forms of unsecured loans.
Generally, a secured loan is easier to get as the presentation of collateral by the borrower reduces the risks to be taken by the lender. It is also characterized by lower interest rates. A borrower with a not-so-good credit history or one that is planning to rebuild credit will more likely be considered for a secured loan than an unsecured loan.
Since it also attracts lower interest rates, a secured loan is a smarter way to manage money as the borrower does not have to pay too much for borrowing. Also, this form of loan gives you access to more money than an unsecured loan does. As far as your collateral is enough to cover the amount that you are applying for.
The inability of lenders to seize the assets of borrowers when they default in repaying the loan puts the lenders’ money in a vulnerable position. Of all forms of unsecured borrowing in America, Credit Cards are the highest with more than 160 million households using it at an average of $7,519 debt per household as of mid of 2021. The nation’s federal reserve also revealed that America’s total credit card debt accumulation is about $770 billion in the same period.
These factors are necessary to be considered when trying to decide between a secured loan and an unsecured loan. Do you want to enjoy more credit limits at a more favorable interest rate? Do you have collateral that is enough to cover the amount you wish to borrow? All these questions and more are vital to your decision-making process.
Features of a secured loan
- Secured loans are given to entities that bear the ownership of the assets that are presented as collateral. For example, a secured loan cannot be approved to Danny when the ownership of the collateral reads Danny and Sons.
- Secured loans get fast approval. Since the borrower is pledging collateral, it, therefore, builds the lender’s confidence to release funds since the latter’s risk has been minimized with the presentation of a valuable asset as collateral.
- Non-salary earners can have this type of loan. Unlike unsecured loans like pay-day loans, you don’t have to be a salaried individual to access a secured loan.
- Guarantors are not needed for this form of loan. All the security that the lender needs is in the collateral. This explains why lenders of secured loans always say that the value of the collateral must be worth the loan amount.
- Lenders can repossess the collateral if the borrower fails to pay it back. This is probably why the secured loan is relatively easier to get. Upon failure to pay back as at when due, the financial entity that lends the money has the right to claim ownership of the asset pledged to replace the loan. The same can also choose to sell off the set for the money or keep the collateral for personal use.
Eligibility criteria for a secured loan
To be considered eligible for a secured loan, the following are some of the requirements that applicants must meet;
- You must be 18 years or older. This is not a student loan. So, the lenders must be convinced that they are dealing with an independent and responsible adult. To confirm this, they may ask the borrower to submit acceptable proof of age or means of identity (with age inclusive).
- Collateral must be provided. This is what differentiates a secured loan from any other form of a loan. A loan cannot be declared secured if a valuable asset has not been pledged by the borrower. The presence of collateral reduces the risk taken by the lender. The value of the asset must match or exceed the amount of the loan being applied for.
Advantages of secured loans.
- Secured loans come at a lower interest rate. This is because since the lender already has the borrower’s collateral with them, they do not need to impose a higher cut-throat interest rate on them. The collateral protects the lender’s investment in the borrower and reduces the need for a high-interest rate.
- With the collateral reducing the lender’s risk, the borrower has access to more amounts to be disbursed. Since the risks involved in an unsecured loan is high on the side of the lender, they tend to minimize their risk by limiting the amount that they can give out. As for secured loans, borrowers stand to get more funds to solve their financial problems.
- Secured loans are usually characterized by flexible repayment terms. This means borrowers don’t have to worry about charges and fines. You can also decide to close your loan earlier than the time agreed upon starting the loan process and extend the tenure of the same loan.
- Your credit score does not play the role of a major factor while reviewing your loan application. As far as you have a valuable asset to pledge, the secured loan is a great loan option if you don’t have a good credit score or you are looking at building credits.
- Secured loans like mortgage loans allow you to deduct some percentages of the interest that you pay from your taxes. That way, you have eased off some tax burdens.
Disadvantages of secured loans
- When you fail in your repayment agreement, you stand the risk of losing your collateral to the lender. The entity that lends you the money has the right to claim the asset that you pledged for in exchange for the loan (irrespective of how valuable it is).
- Secured loans require heavy paperwork and this may be stressful. Aside from the regular documentation, the lender may insist on other documents that may be stressful to get. The filling process too may be cumbersome and prone to errors.
- As an applicant, the assets that are acceptable are those that you are the full owner of. The collateral must not be co-owned by anybody else. Even if you own the largest share of the asset, it will not be accepted as collateral. The asset’s document(s) must also prove that you are the sole owner.
- Secured loans are not as flexible as unsecured loans for borrowings. While unsecured loans allow you to spend the money on items of your choice, secured loans are not like that. For example, an auto loan is tied to a vehicle and a mortgage loan to a house.
Features of an unsecured loan
- Smaller amounts are involved. Since they are not protected by the security of collateral, the lender is taking a huge risk by giving the fund to the borrower. as a result, the former takes safety measures by limiting the risk to smaller amounts. This is unlike secured loans where huge amounts are given to the borrower.
- Unsecured loans are characterized by high-interest rates. This is another by-product of the non-existence of collateral on this type of loan. It is characterized by higher interest rates. An average credit account can attract as much as a 15-18% interest rate.
Advantages of unsecured loan
- This type of loan is usually convenient, and easy for a borrower with a good credit score to qualify for. It is a great source of raising funds for emergencies and is good to achieve short-term goals.
- If you are faithful with your repayment plan, an unsecured loan can help improve your credit score. This increases your chances of getting better loan deals in the future at more favorable terms and interest rates.
- You are at liberty to spend the money in areas that please you. Unlike secured loans like car loans and mortgage loans, unsecured loans do not restrict what you use the money for. So, you are at liberty to spend it on an item or several others. The general rule is that you must be disciplined in your spending.
Disadvantages of unsecured loan
- It attracts a higher interest rate. Since the lender is taking more risks than they would in the case of a secured loan, the price that you pay is to repay at a higher interest rate. With this rate, you may be technically paying more than you would for an item if you were paying in cash or with a debit card.
- When you miss a payment or pay late, your credit score is affected. Defaulting in your repayment is dangerous in the case of an unsecured loan because it is captured in your credit report. And your credit report can be requested for review by future lenders, insurance companies, employers, landlords amongst others. Poor ratings may dent your perceived integrity.
Secured loan and unsecured loan; which to pay first?
If you have the combination of secured loan and unsecured loan to pay, and you are struggling to clear both at the same time, you may want to consider settling the secured loan first, then the unsecured later follows.
This is so because if you fail to pay back your secured loan within the agreed period, you may risk losing your car, or house, or any other asset that had presented as collateral at the point of applying for the loan.
However, have it at the back of your mind that failure to make timely payment on your unsecured loan is capable of driving you deeper into debt. This is so because it is no news that unsecured loans attract higher interest rates. So, when you default, your debts accumulate and your poor performance is reflected on your credit score and credit report as a whole.
If you still find yourself in a dilemma when deciding between a secured loan and an unsecured loan, you can talk to certified credit counselors. They advise you on how to manage your finances, which includes advising you on which is better for you between the secured loan and unsecured loan as well as adequately paying off your debts. Upon objectively observing your financial situation, they provide consultation services that are targeted at making you take the best approach to live a financially secure life.