Differences Between Secured and Unsecured Loans
- November 25, 2019
- Will Turner
The world financial system has been expanding significantly after the crisis of 2008/9. In this period, we have seen many financial products and services launched around the world. For example, cryptocurrency was among the first major results of the crisis. We have also seen many products launched during this time. They include many crypto-related products and many peer-to-peer lending platforms. This has led to an increase of loans and credit in the world today. It is estimated that the total amount of outstanding loans is worth more than $30 trillion. In this article, we will look at secured and unsecured loans and their differences.
A secured loan is any loan that is backed by anything. With this loan, the borrower pledges an asset as collateral for the loan, which then becomes a secured debt owed to the creditor who provided it. For example, when you approach a bridge lender for bridge loans, they might ask you for the necessary documents on your property or land. They are using that as leverage to provide you with the required funds that you need. Similarly, when you go to a bank for a loan, they may ask you about collateral. This collateral is what is known as security. The idea is that the bank will lend you money if they have something they can sell if you default. The security of a loan could be an asset like a vehicle, real estate property, or even a small thing like a television set.
An unsecured loan, on the other hand, is one that is based on trust. The lender will conduct a brief analysis of your finances and then decide whether you are a good client or not. They use the available tools to decide whether you will default. For example, they use information from credit bureaus and agencies to see your credit score. The credit score is calculated using your past financial transactions. They will lend you money if you have a good credit score. Unsecured loans are very common these days because technology has made it possible for companies to forecast whether a client will default or not. Some of the companies that provide unsecured loans are Tunaiku, Lending Club, and Prosper.
There are several differences between the two types of loans other than the collateral factor. First, secured loans tend to be much higher than unsecured loans. The reason for this is very simple. While the bank wants you to pay the money, they are at peace knowing that they can auction your asset. This is opposite of an unsecured loans. In most cases, companies that offer unsecured loans start with a minimal amount and increase it as you gain their trust.
Second, unsecured loans tend to have higher interest rates. This is because they usually have more risk compared to secured loans. As such, lenders use higher interest rates as a security or as an insurance for the loan. In the past, we have seen many unsecured loan companies charge interest as high as more than 50%. They do this for people with a poor credit score.
Third, unsecured loans tend to have a shorter duration than secured loans. It is not uncommon to see many secured loans have a duration of more than ten years. Most unsecured loans have a term that is below one year. This is simply because these companies have a lot of fear of defaults.
Therefore, as a borrower, it is important that you consider the type of loans that you want to take. A secured loan may seem like a good option but it also comes with the risk of you losing a big possession like a house or a car.