You might feel that while browsing through the options of personal loans, you are a little overwhelmed – there is a lot of jargon floating around. This is why it is necessary to know about what you are going for in order to make an informed financial decision.
In the most basic sense, personal loans are divided into two categories: secured and unsecured ones. Here we look at both of them to give you a basic understanding of the two.
What is an unsecured loan?
An unsecured loan is given on the basis of the credit-worthiness of the borrower in question. This is so because there is no collateral backing up the loan. Therefore, if a borrower can’t pay back the loan, the bank’s only line of action would be to take the borrower to the court and obtain a judgment against them. With this judgment in place, the bank can then take out small increments from the borrower’s monthly paycheck to pay towards the loan.
The outcome is less rosy for the bank if the borrower in question files for bankruptcy. In this scenario, the bank is likely to receive payment from the proceeds after all other creditors have been dealt with. Consequently, an unsecured loan is deemed as a very risky endeavor by many banks. And in order to mitigate the risk, banks usually link higher interest rates to them. In some cases, like with credit cards, issuing banks also put a ceiling or credit limit on the amount that can be borrowed by an individual in a given time period.
Borrowers who normally obtain unsecured loans have a great credit history and/or a high net worth. These two factors assure the bank that the borrower has the means to pay back the loan even if it is not guaranteed by a property.
What is a secured loan?
As can be deduced from the name, a secured loan is offered against an asset. For instance, a car in the case of an auto loan or a house with a mortgage loan. These assets act as collateral for the loan in question. In other words, the lending bank can repossess the asset in question if the borrower fails to repay the loan according to the predefined terms. The bank then would sell this repossessed property in order to pay towards the loan.
However, it is important to mention that oftentimes a simple repossession doesn’t solve the issue of a defaulted secured loan. In many cases, the repossessed property doesn’t sell for enough money to completely cover the outstanding balance of the loan. Therefore you could still end up owing a portion of the loan to the bank.
Typically, secured loans are easier to get because the bank carries a lesser amount of risk. Emphasis is still placed on your credit history but not as much as in the case of an unsecured loan. Furthermore, secured loans also come with higher loan limits and a lower interest rate.
In conclusion, while choosing between an unsecured and a secured personal loan, weigh the pros and cons of each one of them. And remember to shop around before making the final decision. We, here at One Stop Funding Shop, strive to make such decisions easier for you by providing you with all the requisite guidance. With over 20 years of experience in the field, we will make sure that you get the financing you need on the best terms possible.