Ever found yourself wondering what the key differences are between secured vs unsecured loans? Understanding the difference between secured vs unsecured debt can position you to make smart financial decisions if you need to leverage a loan.
Loans are a form of debt, and people take out loans for a variety of reasons. For instance, you may take out a loan to purchase a home or for a car. You may also take out student loans for your education. It's also not uncommon for people dealing with health issues to take out medical loans.
However, not all loan debt is equal, and without care, it can get really expensive or worse, even leading to bankruptcy. So what is the difference between secured and unsecured loans, and how do they affect your finances?
Let's get into the key details so you can understand the differences between secured vs unsecured debt/loans.
What is a secured loan?
A secured loan is a type of debt that is backed by an asset that acts as collateral. Basically, the lender, also known as the lienholder, can seize the associated collateral and use it to pay your debt if you fall behind on your payments.
Secured loans are typically less risky for lenders. This is because they have assets associated with the debt. As a result, interest rates for secured loans are typically lower than unsecured debt.
The difference between secured and unsecured loans is that an unsecured loan does not require collateral, and a secured loan does.
Secured loan examples
Here are some secured loan examples so you can better see the difference between secured and unsecured loans:
Mortgage loans
One of the most popular secured loan examples is a mortgage loan. Mortgages are tied to an asset, for instance, a residential or commercial piece of real estate. Typically, you take out a mortgage on a property with predetermined monthly payments.
If you default on your payments, your lender will send you past due notices. If this goes on for an extended time period, they might begin foreclosure proceedings to repossess the asset.
They will then attempt to sell the property to cover the debt you owe. However, if the sale of the asset does not cover the debt in its entirety, you may be liable for the difference.
Auto loans
Next up on the secure loan examples list are auto loans! Remember, you don't really own the asset (your car) outright until you pay the debt in full. So, if you don't make your payments, your lender will repossess the vehicle.
Therefore the car is the asset you are borrowing against, and if you don't pay, you can lose it. That's why it's essential to purchase a vehicle you can afford and get into a cheaper rate so you can save money!
Secured credit cards
Now that we've talked about secured loans, you might also be wondering about secured credit cards. A secured credit card is a type of card that requires a security deposit. This deposit can be as low as $200 and is usually equal to your desired credit limit.
The credit card issuer holds onto your deposit in case you default on your payments. You can use a secured credit card if you need to improve your credit score and history. If you default on the loan, then they use your deposit to pay off the debt.
What is an unsecured loan?
On the other hand, an unsecured loan or unsecured debt is a type of debt that is not tied to any asset as collateral.
As a result, these loan types are risker for lenders and typically come with higher interest rates. This is why a mortgage interest rate can be 5%, and a credit card's interest rate can be 20%.
Although they can't repossess an asset, it can still have a negative impact on your finances if you default on your payments.
Unsecured loan examples
Below are some common unsecured loan examples. Remember, when comparing secured vs unsecured loans, the interest rate for an unsecured loan is usually much higher. Again, this is because this type of loan is much riskier to the lender.
Personal loans
Personal loans are one of the unsecured loan examples you are probably familiar with. You can use personal loans to consolidate credit card debt, student loan debt, and medical bills.
Sometimes people use them for starting a business or things such as auto repairs, etc. However, they typically come with a higher interest rate than a secured loan does.
Credit cards
Again, credit cards can be secured and unsecured loans. An unsecured credit card does not require a security deposit. Your line of credit is based on your credit score, history, and income.
Although you see promotions for 0% interest, it's still essential to pay these off every month because once the promo is over, the rate can skyrocket to an amount you are unable to afford!
Student loans
Student loans are another example of unsecured loans. No matter what type of student loan you take on, it can get costly.
In fact, the average federal student loan debt is $36,510. Private student loan debt comes with an average and hefty price tag of $54,921 per borrower!
Also, lenders can capitalize on the interest, which can create a cycle of debt that is hard to dig out of. So, before applying for student loans, try to find alternatives to fund your education to cut costs.
So now you know the difference between secured and unsecured loans, let's dig into how they affect your credit.
Secured vs unsecured loans: Credit reporting
When comparing secured vs unsecured debt, keep in mind that both can have a huge impact on your finances. Failing to pay any debt can result in late fees, penalties, and negative remarks on your credit.
If you default on a secured loan, you will lose whatever asset that was securing the loan. An unpaid unsecured loan will go to collections. With debt like back owed child support, it can result in jail time by court order.
All of these actions can hurt your credit score, making it hard for you to secure good loan terms in the future. It may also impact your ability to even get a loan or any form of credit at all. Yup, this includes actions taken by child support enforcement agencies about unpaid child support.
Using secured vs unsecured loans
When it comes to using secured and unsecured loans, you want to make sure you are being intentional. It's important to know what each loan type could cost you in terms of collateral required and interest charged. You can do this by shopping around for the best loan rates and offers.
You also want to make sure you are not borrowing more than you really need or can afford. It's not a bad idea to see how much you can save on your own before you consider leveraging debt.
For instance, the last thing you want is for your property to be repossessed or taken because you could not afford a secured loan.
At the end of the day, debt comes at a cost, and that cost is in the form of interest. So it's important to be cautious when it comes to leveraging debt.
Keep in mind, you can save up for those big purchases instead of taking out a loan. Make saving fun and enroll in our completely free "savings challenge bundle!" It includes the 26-week savings challenge, the $5 savings challenge, and more!
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