In the world of personal finance, there are essentially two types of loans. One is called a secured loan and the other is called an unsecured loan. With a secured loan, the applicant has to put up some form of collateral. These loans are called secured because they are backed by an asset which is owned by the applicant. A perfect example of a secured loan would include a mortgage, one where the bank or financial institution’s risk is lowered because the house is used as collateral. So, what is an unsecured loan? More importantly, what types of unsecured loans are there?
An unsecured loan is one where there is no collateral or lien against the loan. It is considered uncollateralized and the applicant doesn’t need to put up any assets to back up the loan. Typically, people applying for unsecured loans have to have a high credit rating, which means they’ve demonstrated an ability to repay previous payday advance loans without defaulting. The approval process for this type of loan is fairly quick. However, due to the nature of the loan, and the fact that it is considered uncollateralized, the interest rates tend to be higher.
Revolving Line of Credit: Revolving lines of credit typically involve lower interest rates and are used by homeowners and businesses as a means of financing. These types of loans have a maximum amount that can be withdrawn during the duration of the loan. It is called revolving because the individual can continue to draw on the credit line so long as he or she does not exceed the maximum amount as defined by the credit line. Any payments made reduce the balances owing, while still allowing the individual to continue to withdraw funds up to the maximum amount within the agreement.
Credit Cards: This type of unsecured loan tends to have higher interest rates and allows individuals to secure short-term cash advances. Credit cards are often used at point of sale transactions when individuals purchase goods and services. The amount the individual can borrow is predetermined by their credit rating. Interest is charged on outstanding balances for those purchases made the month prior.
Student Loans: Student loans are typically provided as low interest rate loans in order to allow individuals to pay for a college or university education. Repayment periods are longer and interest rates tend to be lower. It’s also common for these types of loans to be provided through different branches of the government.
Individuals that use unsecured personal loans must pay close attention to these aforementioned interest rates as they are applied against the outstanding balances on the loan until that loan is repaid in full. It’s common for individuals to allow these interest rates to build up over time, which ultimately means it will take longer to repay the loan.
Secured Loans vs Unsecured Loans
In today’s confusing world of finance and banking institutions, it can be easy to get lost in all the terminology. When it comes to loans, financial rules separate these into two categories: secured and unsecured. The crucial difference between these two categories of loans is that one type of loan is backed by a material or financially valuable asset and the other type is not.
When a financial institution or bank agrees to loan an individual some money, they often require a guarantee in case of repayment. A house or any other valuable material can be held as collateral in case of non-payment, known more succinctly as a secured loan. If individuals fail to make their loan repayments in a timely fashion, the bank or financial institution lender can seize the item or property.
Many people fail to understand the critical fact that they can continue to still be liable for debt repayments even if their lender does seize their property. Generally speaking, banks and financial institutions will take repossessed or seized property and sell it, using the proceeds towards the loan. But if the repossessed property fails to sell for enough money to cover the loan and mandatory fees, the individual continues to be liable to pay for the difference.
Many secured loans, particularly mortgages, can make an individual eligible for substantial tax deductions.
An unsecured loan is usually more difficult to secure from a financial institution or bank because the lender has no recourse in case of non-payment. An unsecured loan can only be obtained after the lending institution or bank performs a thorough analysis of the borrower’s creditworthiness. Usually, only potential borrowers with very high credit ratings will be approved for an unsecured loan. These types of unsecured loans are often called signature loans or personal loans because they are based on the merit of the individual in question.
In some cases, these unsecured loans are known as “character loans” because they are being approved on the basis of individual knowledge of the borrower. Celebrities, prominent members of society and others can benefit from personalized treatment from banks and lending institutions in the form of unsecured character loans.
Because an unsecured loan poses a larger risk for the lender, unsecured loans generally carry higher interest rates than secured loans. Even so, sometimes unsecured loans from certain banks or lending institutions can carry a lower interest rates than credit cards. Many savvy borrowers establish unsecured loans as a type of revolving line of credit, giving them flexible financial options for short-term needs. Borrowers must be very careful with short-term unsecured loans, as they often come with a variable interest rate that can leave imprudent people caught short if not carefully monitored.
Unsecured loans unfortunately do not directly qualify individuals for tax deductions.
Personal Loans to Replace Credit Cards
Personal loans existed as a way for consumers to access short term credit long before credit cards were even invented. When they first became available, credit cards were actually charge cards which required the holder to pay off the entire balance next month. They became popular as a convenient payment tool and began being accepted by a growing number of merchants. Financial institutions then allowed consumers to have a revolving line of credit, which let them pay for their purchases over time. This has led to the credit card becoming the number one borrowing product for consumers and personal loans lost a lot of their appeal.
There are, however, several disadvantages to using credit cards. One of them is the psychological effect created by having the ability to purchase something without paying for it right away. A popular study in 2001 indicates that individuals would be willing to spend up to twice as much for the same exact product if they were using a credit card. This means that consumers are less likely to comparison shop in order to see whether they could get the same item at a lower price somewhere else. Furthermore, using a credit card can lead to impulsive buying where people purchase items that they don’t really need or may not even particularly want. All of this leads to consumers piling up debt faster than they would imagine.
Another big disadvantage of credit cards is the interest rate. Few consumers actually pay much attention to interest rates and banks are taking advantage of it. The rates on credit cards typically range between 13% to over 35%. If one doesn’t pay the full balance on their credit card statement, they start paying interest, which is exactly what the banks want.
Personal loans, on the other hand, have their unique set of advantages over credit cards. They come as a fixed amount that is given to the borrower in a lump sum and the interest rate on the loan is usually fixed for the entire term. The consumer can’t borrow more money without filling out an additional loan application, which discourages overspending.
The amount of the loan, plus applicable interest is paid back in equal payments over a fixed period, which can range between one to five years. In the majority of cases, there is no penalty if a borrower pays off the loan early or if they pay more than the regular monthly payment owed. Interest rates on personal loans will often be much lower than with credit cards.
A lot of consumers have now become aware of the positive aspects of personal loans and are increasingly using them to finance larger expenses, such as home or car repairs. Many new online lenders have appeared, offering personal loans with favorable terms and interest rates to consumers. Their growth in popularity has led to millions of individuals opting for a personal loan rather than putting a purchase on their credit card.