Navigating the different types of loans can be a tricky process, but it gets a lot easier if you understand the key basics of lending. From mortgages to medical debt, and everything in between, loans generally fall into one of two categories: secured and unsecured. What is the difference and how does it affect you? Read on to find out.
A secured loan refers to any type of loan that requires the borrower to offer some type of collateral to the bank or lender. This means you must offer some sort of tangible personal property to back the loan so that if you default on your payments, the lender may confiscate the property to help make up for the loss on the loan. The most common types of secured loans are mortgages and car loans. In each of these instances, your home or your car serve as collateral may be taken away in the case of a loan default.
However, other types of loans can be secured as well. Some banks, for instance, require borrowers who take out a personal loan to use a savings account as collateral. While it’s important to pay all of your bills on time, secured loans are particularly significant because you run the risk of losing your property or savings in the event of default.
Unlike secured loans, unsecured loans do not require any type of collateral from the borrower. Credit card debt is the most common type of unsecured loan, and payday loans and student loans also fall into this category. Instead of asking for collateral, lenders rely more heavily upon your credit history and overall financial picture in determining whether you run the risk of defaulting on the loan. The less of a risk you are perceived as, the less interest you’ll have to pay.
However, just because you can’t lose your home or car to an unsecured loan, missing payments can still seriously affect your finances. Your credit score will drop and it will become increasing difficult to find loans with competitive interest rates in the future. When possible, prioritize your finances so that you at least meet the minimum payments on each and every one of your loan payments.