The best part of getting a personal loan is that you can use the funds for whatever you need. Whether is is for a vacation, investment or for funding your education. But before you start looking for a personal loan, know that you can get a personal loan that is secured and one that is unsecured.
The basic difference in the two kinds of loans is that a secured loan requires collateral, and an unsecured one does not.
A collateral is a tangible item that you own to use as security for the repayment of the loan. In the event you stop to pay back the loan, the lender can take that collateral from you.
A collateral can be anything that is agreed as security by you and the lender. Traditional banks and credit unions will only use a collateral that has general value to everyone, such as a car or a house. The interest rates are always lower for secured loans since the banks already have some form of repayment by being able to sell the collateral. This is how a foreclosure works. If you are going through a foreclosure, you took a secured loan which the bank would repossess the house to sell it to pay back the loan.
Some lenders will accept a more unique or eclectic collateral, but these banks are specialized at appraising the value of those items. An example would be putting up a watch or art piece.
Pawn shops also work in the sense of giving a secured loan, and pawn shops will also accept a wider variety of items than traditional and specialized lenders. Pawn shops do have much higher interest rates and the duration of the loan is much shorter.
An advantage of secured loans over unsecured loans is that your credit score is less important because the lender is more relying on your collateral and focussing less on your credit history. So if you have a bad credit, a secured loan might prove to be easier to get approval.
A disadvantage with secured loans is that lenders are less flexible if you are not able to pay the loan. This is because they have the right to repossess the collateral.
An unsecured loan does not require collateral, and the lender is accepting that you will pay the loan based on your credit score and payment history. In essence, the collateral is your credit, because if end up not paying, the default will impact your credit negatively.
Interest rates are higher because the lender is left with nothing if you do not repay the loan.
If you have have bad credit, you will still be able to get a loan, but most likely not by a local bank or large credit institution. To get approval for an unsecured loan if you have bad credit, smaller lenders will contact you based on your information and from there you can compare their rates offered.
An advantage of an unsecured personal loan is it is less harmful to your livelihood if you end up not paying the loan. An unsecured loan will affect your credit, but it will not repossess an important item in your life, such as a car or house.
Also, because of the lack of collateral, if you begin to not pay an unsecured loan, a lender might be more flexible with renegotiating terms with you because it is more favorable for them to get something than nothing.
So as to to sum up:
Advantage of Secured loan over unsecured loan:
- Amount borrowed is based on value of loan more so than your income.
- Bad credit more accepted compared to unsecured loans.
- Approval is higher because of the security placed on the loan as opposed to unsecured loans.
- Interest rates are lower due to the lower risk for the lender.
Advantage of unsecured loan over unsecured loan:
- No valuable item at risk in case you cannot pay the loan back.
- Smaller lenders are more flexible to renegotiate the original terms in the case of default.
- Amount of loan is not limited on the value of the security, so if you can prove high income, you would be able have a higher loan amount.
These are the differences between a secured and an unsecured loan. However, with each kind of loan there are differences between the lenders and your particular situation. Is is beneficial to discuss with various lenders who lend secured and unsecured and see what best fits your purpose.