What’s the Difference between Secured and Unsecured Loans?
Loans can be tricky. With so many different options, how do you decide which one is right for you? For starters, it depends what you plan to purchase with the loan. Are you looking to take a vacation or buy a new home? The amount of money you’re borrowing will determine if you need an unsecured or secured loan.
Taking out a loan is a big financial commitment. By doing so, you’re essentially agreeing to give up a portion of your paycheck until the loan is paid off.
In case you’re wondering, an unsecured loan, or signature loan, is a loan in which you don’t have to give the lender rights to a specific asset if you’re unable to repay the loan. This type of loan is generally taken out for home improvements, business opportunities, startups or business expansion, personal loans for debt consolidation, investments or profitable opportunities. If you default on the loan, there’s nothing the creditor can take back to recover their loss of payment. With no protection if you default, interest rates are generally higher. But it is often a good idea to borrow more than one may need in order to put money aside to meet the oncoming payments for a period so as not to be late or default, thereby damaging your credit in a very unplanned-for and disappointing way.
If you decide a secured loan is for you, what type of collateral must you provide? Depending on the terms of the agreement, it could be something as large as your home or your car. Secured loans generally offer lower rates, a higher borrowing limit and longer repayment terms due to the large sum of money that’s borrowed.
While you’re offering something up as collateral, that doesn’t necessarily mean you’ll lose your collateral for missing a payment or two. For example, if you take out a home equity loan, your home is your collateral. However, if you miss out on a payment, the lender is more likely to send you a letter requesting that you make your payment rather than take over possession. In the long run, it’ll take too much work and time for the lender to take over possession of your collateral for only missing a few payments. (Note: Just so we’re clear, I’m in no way suggesting it’s OK for you to blow off your payments every once in a while. Keeping up to date is much better in the long run.)
Now that we know what unsecured and secured loans are, how can debt from each affect you? A small portion (about 10%) of your credit score is based on the type of debt you carry and whether or not you have a variety of credit types. Revolving credit, or credit that’s automatically renewed as debts are paid off, and installment loans are also taken into consideration. The better you are at paying off your debts on time, the better off your credit score will be in the long run.
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