Almost all of us are required to borrow money at some time in our lives – unless you are a member of that 1%. We borrow money to buy our homes and our automobiles. Sometimes we need to borrow money to pay our taxes or for college. When this time comes, we usually need to choose between unsecured personal loans and secured loans.
The main difference for unsecured personal loans
If you’re not familiar with secured and unsecured personal loans the major difference is that to get a secured loan you need to put up an asset as collateral. That asset could be a boat, a second home, an RV or your house. The important thing is that the loan is secured against the collateral in the event you were to default. In this case, your lender will sell the asset. If this doesn’t generate enough money to pay off the debt, your creditor could then obtain what’s called a deficiency judgment against you for the remaining amount.
An unsecured debt is the opposite of this in that it’s not connected to a specific asset. If you were to default on an unsecured loan, the borrower could only come after you and not any of your assets. As a general rule, secured loans have lower interest rates than unsecured loans because the lender is not taking as much of a risk. However, there are other factors that lenders take into consideration when setting an interest rate that generally include your credit history, the expected returns and your ability to repay.
The pros and cons of unsecured personal loans
The biggest pro of unsecured personal loans is what you’ve already read that you aren’t required to put up any asset to secure it. These loans are often called signature loans because all that’s required is for you to sign for it. This means that if you were to default on the loan you would not be at risk of losing an important asset such as your house.
In addition, unsecured personal loans generally have a simpler application process. Whether or not you get the loan is based mostly on your credit history and credit score. Plus, of course, you must have a steady and dependable source of income.
As you have read, the biggest con of unsecured personal loans is that lenders generally charge a couple of additional percentage points so that your interest rate would be higher. A second downside of unsecured personal loans is that you may not be able to get as much money as with a secured loan. The issue here again is one of risk. Lenders are professionals at assessing risk and an unsecured personal loan represents the biggest possible risk since there is no property securing it.
Unsecured personal loans generally have shorter terms than secured ones. Most lenders don’t offer unsecured personal loans with terms of more than four years as opposed to the 10 or 15 years you would get with a secured loan. This is due to the fact that there is usually less money involved in an unsecured loan. The logic here is that because the loan is for less money, there is no reason to spread it over a longer period of time
When another financial problem crops up
Finally, a problem with unsecured personal loans is what happens if you get one because you’re in trouble financially. If another financial problem then crops up when you’re in the middle of paying off that first loan, you could find yourself in even more trouble. And as a very wise man once said, you can’t borrow your way out of debt.
The most common types of secured personal loans
There are two common types of secured personal loans. They are a home equity loan and a homeowner’s equity line of credit, which is commonly called a HELOC. There are major differences between the two. One is that with a home equity loan you get the total loan amount all at once. With a HELOC, you’re given a checkbook or debit card and can then draw on the funds as needed. A second difference is that with a home equity loan you have a fixed payment at a fixed interest rate. But with a HELOC, the interest is variable and can and will go up and down monthly. Also, with a HELOC you will have a minimum monthly payment but can pay any amount each month so long as it is more than the required minimum. At the end of the HELOC, which is generally seven or 10 years, there is usually a balloon payment where you would be required to pay the full amount of your principle. Alternately, you could be required to pay based on a loan amortization schedule.
If you cannot qualify for either
If you’re in really serious financial shape you may find that you can’t qualify for a either secured or unsecured personal loan. In this case, your best option might be what’s called debt settlement or debt negotiation. This is where a company like National Debt Relief negotiates with your creditors to get your debts reduced to a fraction of what you owe. In fact, if you owe more than $10,000 and are four months or more behind in your payments then letting National Debt Relief or some other trustworthy debt settlement company settle your debts could be your best option by far.