Are you thinking about taking out a loan? It will be a good idea for starters to decide which one to choose – secured or unsecured. A secured loan is backed by collateral – either in the form of an asset or property, in most cases. Those looking for some extra cash are usually faced with the dilemma of choosing from various lenders and the type of loans to acquire. If you do not know which loan option best suits your needs, it is recommended that the difference between secured and unsecured loans is understood in its entirety.
For secured loans, the borrowing party agrees to secure the payment of the loan amount through an asset value – value equivalent to the amount of loan taken out. As this is a credit gamble for the lender, the interest rates offered on secured loans are usually not as high as those offered on unsecured loans.
On the contrary, an unsecured loan does not require the borrower to safeguard the loan amount through collateral. However, in such cases, the loan is extended based on the credit history and worthiness of the borrowing party. Hence, despite being quick money, an unsecured loan comes with strings attached. For an unsecured loan, you need to provide the lender with an immaculate credit history to attract a lower interest rate on the loan. Otherwise, interest rates tend to be higher for unsecured loans. Following are a few of the benefits of secured loans.
- Lower interest rate: Given the collateral security that seals this loan agreement, secured loans tend to be less risky for the lenders with the assurance that the borrowing party will repay the loan amount.
If not, the borrower may be required to forfeit the asset set as collateral, and the lender may offer lower interest rates. On the contrary, an unsecured loan will attract a higher interest rate, provided the more significant risk attached to it. - Building credit: Secured loans are the preferred option for those hoping to build credit to enhance their credit history. This is an effective way to improve a credit score, consequently leading to lower interest rates on future loans. In the case of secured loans, the borrowing party is likely to exercise care while paying off the loan amount, as the collateral secured against the loan is at stake. Collateral may be in the form of property or an asset of value. Hence, the payment becomes inevitable on such loans. Paying on time enhances one’s credit score.
- Low risk: It is essential to evaluate the loan from both parties’ perspectives – lender and borrower. From the lender’s point of view, a secured loan comes with a low risk attached. If the borrowing party fails to honor repayment, there is not much to lose. The collateral may be used to forfeit the loan amount; hence, the lender is in a win-win situation.
Based on the various benefits discussed above, even for businesses, secured loans tend to be a viable option as it reflects well on financial statements and bookkeeping records. However, secured loans are not a friendly option under all circumstances owing to the lack of flexibility allowed in the usage of funds. In the case of a secured loan, restrictions are usually placed on using the acquired funds. For instance, if you wish to purchase a vehicle and use the remaining amount to invest in equipment, the lender may not allow the additional purchase by limiting the use of funds provided. Hence, this may be problematic in situations where flexibility is required. Moreover, choosing a loan that has fixed terms, either secured or unsecured, may pose additional penalties to the borrowing party. Selecting a secured loan with variable terms is advisable to avoid penalties.
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