Borrowers are often presented with different types of loans, such as personal loans, cash loans, salary loans, business loans, etc. In general, all loans are distinguished as secured and unsecured. Here’s what you need to know about the difference between these loans and which you should opt for.
What is a Secured Loan?
As the name implies, a secured loan is secured with something that can substitute as payment in case the borrower defaults. This substitute is called “collateral”. Collateral can be your home, car or other things that are valuable to you, of which the amount can cover the loan you have borrowed. Banks usually ask for collateral when the loan is too big. Since it’s inevitable for borrowers to default, banks use the collateral to cover the loan amount.
For example, if a house is used as collateral and the borrower isn’t able to pay back the loan, the bank has the right to foreclose the property and sell it. Once the foreclosure has been initiated, the borrower has to give up the right of ownership over the property.
Pros of a secured loan
- Guaranteed loan application approval
The first advantage of applying for a secured loan is guaranteed approval. Who wouldn’t want a loan application with fast approvals? Banks and other lending institutions tend to approve borrowers if they can present a collateral matching the amount of the loan sought. If you have a property like a house or a car and you need cash right away, you can easily get what you need by pledging your property. If you intend to pay the loan back regularly, you don’t need to worry about your collateral getting foreclosed. So, remember to pay your loans on time periodically.
- No need for a guarantor
Since the collateral serves as your backup, there’s no need for you to present a guarantor or co-borrower in most cases. Banks and lending institutions accept collateral as the only backup as long as it meets the criteria set by them.
- You’ll get encouraged to fully pay your loan
Finally, with a secured loan, you will be encouraged to fully pay your loan. Your property is pledged, and there is a risk that the lender will foreclose it if you don’t pay. That’s enough encouragement for you to pay on time if you don’t want your asset to go to waste.
Cons of a secured loan
- You have to give up your property in case of a default
Although a secured loan provides certain advantages, it also comes with a risk. The first risk you have to take is the idea that you may need to give up your property in case you can’t pay the loan anymore. This is the very reason why loans have collateral. If the borrower can’t pay anymore, lenders will use the collateral to pay for the loan. This is a big risk for borrowers.
- The fair value of your collateral should be more than your loan amount.
Another drawback is the fact that your collateral needs to match the standards set by banks and lending institutions. The fair value of your collateral is essential in this type of loan.
In most cases, lenders determine the fair value based on the market prices. They do the appraisal as part of the process. If your property doesn’t meet the criteria or standards, you might need to provide another property to pledge. Else, your application will get rejected.
- If you don’t have a property to pledge, your loan application will get rejected.
If you don’t own a property to secure as the collateral when you apply for a secured loan, this loan is not the right one for you.
What is an Unsecured Loan?
An unsecured loan is the type of loan that doesn’t need a collateral. As the name suggests, it’s “unsecured,” which means the bank or lender has no property to foreclose if the borrower defaults. Unsecured loans come in handy for people who don’t own properties or don’t want to pledge their assets. It’s also a good option for those who need immediate cash.
Pros of unsecured loans
- There’s no need to involve your assets
The first reason why unsecured loans are good alternatives to borrowers is the fact that there is no asset needed to get a loan. This means whether you own a house or not, you can apply for loans as long as you qualify and have all the necessary documents needed.
- High credit scores and good credit records are often enough
Unsecured loans are also favorable to those who have high credit scores and good credit records. More often than not, credit scores are enough to make you qualified for unsecured loans. For example, if you are applying for a cash loan, you don’t need to provide a lot of documents if you have a high credit score. It’s easy to get approved if your records are good.
- Easy application process
Since unsecured loans don’t need collateral, you don’t have to go through the appraisal process and wait for the lender to determine the fair value of your property. For borrowers, this means an easier application process. You just have to submit your documents and wait for approval.
- Immediate cash for qualified borrowers
Unsecured loans are also for those who need immediate cash. You don’t have to look for collateral anymore if you are qualified. Prepare your documents, show your prospective lender your credit scores, and get your loan approved quickly. For those who are looking for short-term loans, unsecured loans are ideal.
Cons of unsecured loans
- High interest rates
Since the loan is unsecured, the banks and lending institutions impose high charges and penalties for those who violate the terms and conditions. While you can immediately get the loan, you will have to pay high interest rates later on. Some borrowers can tolerate this disadvantage, but it’s costly.
- Bad credit records if you default
If you don’t pay on time or if you default, the lender will have to report it, which means your credit records may get impacted. In addition, bad credit records will affect your future loan applications. So, if you want to avoid that, you should plan your payment timely and wisely.
- Strict loan requirements
Lastly, banks and other lenders are strict when it comes to application. If you don’t meet one or two requirements, your application will be rejected immediately. This is why submitting your complete documents on time is essential. Although the bank will follow up for details needed in an incomplete document submitted, they may queue your application for consideration at a later stage.
How To Choose Between Unsecured And Secured Loans?
The answer depends on what you are looking for and the purpose of the money you want to borrow.
For borrowers with a big loan amount
Secured loans are best for long-term borrowers and those who need a large amount of cash. If you are borrowing to pay for the tuition fee of your kids, renovation of your house, buying another property, or other costly things, then secured loans are suitable. This type of loan has a low interest rate. Even if your payment scheme takes a year or more, you won’t pay big on the interest.
For short-term borrowers
For borrowers who will use the money for monthly expenses, medical bills, or other short-term expenditures, unsecured loans are better. However, remember that you have to pay high interest rates. This is the risk you have to take when borrowing unsecured loans. If you don’t have properties to put as collateral as well, unsecured loans will be your only choice.
Bottom Line
The type of loan you can get will depend on many factors. You also need to consider the requirements. If you think you are not qualified for secured loans, then try applying for unsecured loans. If you need cash immediately and you want guaranteed approval, then secured loans might be a better choice.
