Anytime that you are in the market for a financial product such as a loan it pays to do some research before making any decisions. One of the most basic differences you need to understand is the definition of an unsecured loan versus a secured loan. There are several advantages to choosing an unsecured loan, but also some limitations. This article will attempt to give you a clear definition of an unsecured loan so that you can decide whether or not it is the right one for you.
Collateral Is Key
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The linchpin between these two lending options is collateral. When someone chooses to take out a secured loan this basically means that there is some physical property that will guarantee the lenders repayment. Generally, there are two main types of collateral that one can use. First is a home, this is what is called a second mortgage or home equity loan. Another is an automobile, commonly called a title loan. In both cases, the physical property ensures the lender that should you default on your loan payments they will have recourse though a seizure of your property.
Unsecured loans, on the other hand, do not require that the borrower offer any collateral guarantee on the money they receive. These loans are most famously present through the use of credit cards, but are also present in medical and educational loans. When a loan lacks collateral, it is only the good word of the borrower that assures the lender of repayment.
Getting an Unsecured Loan
This big difference in guarantee between secured loans and unsecured loans also affects the qualifications for obtaining the loan that you want. Without physical property to back it up, most lenders will only offer unsecured loans to people with good credit and adequate income to support the loan's repayment.
Therefore, credit score is often the key to whether or not you are eligible for an unsecured loan. A good credit score assures the lender that you are a responsible financial manager and therefore able to handle the repayment of your loan.
Benefits of the Unsecured Loan Option
As a borrower, there are a few important benefits that are offered to you in choosing to take an unsecured loan. First, the lack of collateral required means that you do not need to own a home or a car to get the funds you need. Especially for younger adults, this is a really great option since they do not likely own property.
Second, for those who do own a home or car that they could leverage, it allows them a bit of breathing room in terms of repayment. Even though failure to make payments on time is damaging to your credit and not a good idea, this kind of product eliminate the fear of losing your home on top of that lower credit score.
Unsecured Lending Drawbacks and Risks
There is a darker side to choosing an unsecured loan, however. To start, the lack of collateral guaranteeing the loan makes it difficult for the lender to offer you his best interest rates. Though your good credit is some assurance that you are good for the money, collateral is a physical element that provides lenders less risk. Therefore, the interest rates are higher.
Next, failure to pay an unsecured loan is more complicated than with secured loans since there is no property to repossess. Generally, if you go delinquent on your loan payments, the lender will send you to collections and may even sue you to get the money you owe debited directly from your paycheck. That is why it is important to be sure that you only take what you can afford in any lending situation.
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