When it comes to taking on debt, there’s two main types of loans. In today’s post we’ll review what the difference is, why you should consider a secured vs. unsecured loan, and which type your current debts fall under.
#1. Secured loans
A secured loan means that you need to put up an asset – such as a house or car – as security for the lender. This is considered “collateral” meaning that if you are unable to pay back the loan the lender has the legal right to take possession of that asset.
Secured loans are often used to consolidate debt – to pay off all your existing loans, so you have only a single payment to make each month at a set time, rather than trying to manage several.
Since you’re putting up collateral, a secured loan usually comes with a very low interest rate. And in some cases a secured might be your only option if:
- You have a bad credit score
- You’re self employed.
- Yo recently changed jobs.
- You want to borrow a large amount.
These scenarios would normally mean you’re seen as a higher lending risk. But if you can’t repay a secured loan, the lender may be able to force you to sell the asset to get back its money.
This security means lenders are more willing to lend – although the better risk you seem, the cheaper the loan will be.
Types of Unsecured Loans
- Home mortgage loan
- Home equity line-of-credit
- Car and auto loans
- Some credit cards
How to compare secured loans
You can compare secured loans for amounts from $10,000 to $250,000, and usually from 5 to 30 years.
- Interest Rates: This is the interest rate you’re charged (known as the APR), and is usually variable. This means they may go up and down, and therefore so will your repayments.
- How to Apply: Lenders may offer lower APRs on bigger or longer loans. And some cheap loans are available only if you apply online.
- Typical Rates: Advertised interest rates are often typical ones – this is the rate that two thirds of successful applicants receive. The rate you will pay depends on your personal credit history.
- Early Payment: There may be a penalty fee if you want to repay the loan early – check with the lender.
Downsides of a Secured Loan
There are a few things to look out for with secured loans:
- The ‘security’ means that the lender may be able to take possession of (“repo) your home to get their money back if you’re unable to repay the loan, and make their monthly payments. Think abut this carefully before taking out a secured loan.
- They are usually taken out for a longer period than unsecured loans. Remember that a long loan with a low APR may cost you more in total than a short loan with a higher APR, even if the monthly repayments are more affordable.
Use the loan sensibly. Do not use it to pay off debts and then borrow more on your credit cards.
#2. Unsecured Loans
With an unsecured personal loan you’re able to borrow money without putting up collateral to secure the loan – your home, for instance, won’t be at risk if you’re unable to repay the money.
There’s a few different types of unsecured loan, and different reasons for using an unsecured loan:
What you can use an unsecured loan for
Unsecured loans are a great way to spread the cost of paying for:
- Buying a Car: Personal loans are usually cheaper vs. car dealers’ loans. You’re essentially paying cash, so you can haggle more to get a better deal!
- Home improvements: Contractors may not accept credit cards and you might need more than a single card’s credit limit to afford a home improvement project.
- Wedding – Having a fixed amount helps you stick to a budget for your big day (and other costs, like the honeymoon after).
- Vacations: A personal loan is a way to pay for things IF you know the exact cost of ( such as a once-in-a-lifetime vacation).
You can also use an unsecured loan to consolidate debt – rearrange and simplify your finances, so you know exactly how much you’re paying at a set time each month.
Types of Unsecured Loans
- Personal loans
- Consumer finance loans (i.e. payments on furniture)
- Student loans
- Some credit cards
- Corporate unsecured debt
Comparing unsecured loans
Unsecured loan rates can be as low as 5-7 percent, but only if you have stellar credit. In most cases you’ll be offered an unsecured loan at 10-15 percent interest.
If you have a poor credit profile (you’ve paid some credit card bills late, for instance), you’re less likely to be accepted for a loan and rates will be higher.
FYI: You may have to get a secured loan if you have had problems with credit in the past.
How unsecured loans differ
Like secured loans, there are also a few different types of unsecured loan. You can compare unsecured loans for any amount – usually from $500 to $20,000 and any period from 1-7 years.
Here’s what to look for with a secured loan:
- Interest rates: The interest rate you’re charged is known as the APR, and is usually fixed for the time of the loan – so your interest won’t go up or down. Different lenders charge different APRs.
- How you apply: Lenders may offer lower APRs on bigger or longer loans. Some cheap loans are available only if you apply online.
- Early repayment: Some loans may have slightly higher APRs but no early-repayment charges. If you think you might want to repay early, ask the lender its policy.
- Other benefits: Some loans may let you make under- or over-payments, or even take payment breaks (months where you don’t have to pay anything) without penalty.