One of the major categorizations of loans is secured and unsecured loans. By definition, secured loans are backed by collateral, whereas unsecured loans do not need any such. Here are the basic differences related to secured and unsecured loans.
Collateral is an asset belonging to the borrower. In case of secured loans, the borrower surrenders the possession of his/her property to the lender while availing the loan. Once the borrower repays the principal and interest completely she/he gains back the possession of her/his property. However, if the borrower fails to repay, the lender may seize it. Most popular examples of unsecured loans are mortgages or auto loans. Generally, banks ask the borrower to get their collateral insured, to compensate for any damage on the same.
In case of unsecured loans, the borrower does not need to surrender any of their assets. Here, if the borrower fails to repay the debt, the lender can sue the former legally, which tends to be time-consuming and complicated for the lender. Credit card is an example of this type of loan. A legal online money lender provides a loan without collateral, which is a form of unsecured loan.
Secured loans are safe and lenders may usually offer such credits at a low rate of interest. On the other hand, unsecured loans are riskier and lenders often charge a considerably higher rate of interest.
Maximum Loan Amount
Consider if the borrower needs to buy a house, which requires a lot of money, and he/she needs a loan. It can be easily processed under the criteria of the secured loan. However, the lender or bank may hesitate to provide an unsecured loan for such hefty amounts because of the risk involved. Thus, secured loans provide the borrower with the more amount of credit compared to the significantly riskier unsecured loans.
Generally, secured loans are offered to anyone who produces an asset as collateral. In contrast, an unsecured loan looks into a lot of things about the borrower. It takes into account the credit score, employment status, and the debt-income ratio. Hence, to avail an unsecured loan the borrower needs to have a good credit score, solid employment, and a decent debt-income ratio.
On considering everything, unsecured loans tend to be of high cost and lead the people to an unsustainable debt path. On the other hand, secured loans are a responsible choice. However, when it comes to debt, prudence is the operative word.