When it comes to loan options, it may seem as if the possibilities are never-ending. The finance industry has gotten very creative, especially in the past few years, but it may help to remember that there are really only two types of loans: secured and unsecured.
Secured loans
The word “secured” means that there is something of value backing up the loan. When you get a secured loan, you pledge a piece of property or something of financial value that the lender can seize if you don’t fulfill your payment responsibilities.
There are several different types of secured loan options. Two of the most common are mortgages and auto loans.
With a home loan, the house you buy is the collateral. If you don’t make your payments, your lender can foreclose on the home, force you to move out and then sell it to recoup its investment.
The same principle governs car loans. If you don’t make your payments according to the terms of the contract, the lender will seize the car and sell it.
Other secured loans include pawnshop loans, loans from investment accounts and insurance policies and prepaid or secured credit cards. In these cases, instead of using the loan to purchase the item that will be your collateral, you borrow against collateral you already own.
One advantage to many secured loans is that the interest rates are lower. When a lender has collateral backing up the loan, the risk of losing money is less, which means the lender needs less of an interest rate premium.
Mortgages generally have the lowest long-term interest rates, while car loan rates can be nearly as low. Loans on investments and insurance policies are usually lower than those on personal loans and credit cards. Plus, in many cases, you are paying interest to yourself.
A drawback to secured loans, of course, is that you can lose your collateral if you don’t make the payments as prescribed in your contract.
Unsecured loans
Unsecured loans are so called because you don’t need collateral to get the loan. Credit cards and personal loans are among the unsecured loan options.
With an unsecured loan, the lender has only your promise to repay, making the loans more risky.
Because of this, the interest rates on secured loans are generally much higher than those on secured loans. For example, credit card rates can be as high as 20 or 25 percent. This is one drawback of unsecured loan.
Another drawback to unsecured loans is that the amount of money you can borrow is usually a lot less than with a secured loan, which is due to the lack of collateral.
An advantage to unsecured loans is that they are relatively easy to get. Assuming you have a decent credit score, you can often get a credit card the same day you apply.
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