All types of loans, no matter what they are, are either secured or unsecured.Knowing the difference can better help you understand how they work and what to expect when applying for one. But always remember before applying for any loan, make sure you check your credit score first. As if your score is already low this will have a negative impact and lessen any chance of being accepted in the first place.
Secured Loans
A secured loan is one that relies on an asset, such as a home or car, as collateral for the loan. In the event of default, the lender can take possession of the asset (repossession of your home or repossess a car, for example) and sell it to recover the amount of money borrowed. For this reason, interest rates for secured loans are often lower than those for unsecured loans. In many cases, such as in the purchase of a home, the asset to be used as the collateral will need to be appraised before the terms of the agreement can be set. Examples of secured loans are:
Car loans
Boat (and other recreational vehicle) loans
Mortgages
Construction loans
Home equity loans
Home equity lines of credit
Unsecured Loans
Unsecured loans do not require the borrower to put forth an asset for collateral. The lender relies solely on the borrower’s credit history and income to qualify him for the loan. If the borrower defaults, the lender usually has to try to collect the unpaid balance through a variety of efforts. Which may include using collection agencies, freezing accounts, lawsuits, and garnishing wages. Because there is a considerably higher assumption of risk on the lender’s part with an unsecured loan, the interest rate is usually much higher. They are often more difficult to obtain and the amounts loaned are usually lower than that for secured loans. Examples of these are:
Personal loans
Personal lines of credit
Student loans
Credit cards/department store cards
Payday Loans
Payday loans are relatively new on the finance scene. They are short-term loans borrowed using the borrower’s next paycheck as guarantee for the loan so, in a way, they are secured. However, payday loans have notoriously high annual percentage rates (APRs) and can be difficult to pay off. Banks do not generally offer Payday loans. Most establishments offering them are private companies with separate storefronts.
Title Loans
A title loan, also fairly new, is a type of secured loan where the borrower can use their vehicle title as collateral. Borrowers who get them must allow a lender to place a line on their car title, and temporarily surrender the hard copy of their vehicle title. In exchange for a loan amount. When the loan is repaid, the line is removed and the car title is returned to its owner. If the borrower defaults on their payments then the lender can repossess the vehicle and sell it to repay the borrowers’ outstanding debt. Typically, the same companies that offer Payday loans will also offer title loans. However this is bigger in the U.S.A than the U.K
Student Loans
Student loans are, of course, used to get a person through college or other educational institution. There are many different types of these including:
Private loans, usually sought by parents of students ineligible for other aid or those who do not receive enough aid to cover the cost of attendance. In many cases, these must be secured by some form of collateral.
Government Loans, these usually do not need to be paid back until the borrower starts earning above £20,000 per Annum, however the U.K Government are talking about changing the rules for this very soon.
Mortgages
Mortgages are probably the most complicated types of loans and have the most variations, the first being who is underwriting or guaranteeing the loan. A mortgage and the various types can be explained more here in the mortgages section.
Home Equity Loans
A home equity loan is a loan for a fixed amount of money that is secured by a home. The borrower agrees to repay the amount with equal monthly payments over a fixed term, just like the original mortgage. If the borrower defaults on the payments, the lender can repossess the home. A homeowner must have equity in the home to get a home equity loan, thus the name. The equity is the appraised value of the home minus the amount still owed on the original mortgage. Usually, the maximum amount is for a certain percentage, say 90%, of the total value of the home minus the amount of the original mortgage.