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Secured and Unsecured Loans

A loan is a form of debt or credit provided by a lender to a borrower. The loan providers generally offer two types of loans, known as secured and unsecured loans. A loan provided by the lender could be offered against collateral or without it. Collateral is a security that the borrower provides the lender, and the lender can recover his money by selling off the collateral in case the borrower defaults in making timely payment. This type of a loan is called a secured loan. Examples of a secured loan are a mortgage, home equity or an auto loan.

On the other hand, if the lender provides a loan to a borrower without any pledge of collateral, it is called an unsecured loan. This type of loan is also sometimes referred to as a signature loan, the signature of the borrower being the only collateral required for the loan. An unsecured loan is based on the borrower’s credit. Some examples of an unsecured loan are credit cards, personal loans, payday etc.

Secured Loan

In case you decide to obtain a secured loan you must be prepared for the consequences that might follow should you fail to make payment. You may have to forfeit the collateral (usually your house) to the lender if you do not repay the amount as per the agreement. The lender can sell your property to collect the balance due from you. So be sure that you can afford to pay the monthly installments before going in for a secured loan. It has its own advantages, though. A secured loan is more readily available and in fact at lower interest rates than an unsecured loan. It also comes with the benefit of being repayable at lower monthly installments with longer tenures.

Unsecured Loan

An unsecured loan, on the other hand, does not pose a threat to your assets as it requires no collateral. The application processing is easy and quick, with very little documentation required.

Other Loan Types

Mortgage: A mortgage implies pledging your property as collateral to the lender who extends some kind of loan to you. A home mortgage is one of the most common means of obtaining credit. Since a person cannot hide a house in case of financial trouble, a home mortgage is considered a safe bet by the lender. This loan can be used for constructing or buying a new house, or for refinancing or restructuring the home.

Home equity: The difference between your home’s worth and the amount you owe on mortgage is your home equity. In other words, this is the difference between the value of your house and the balance outstanding in your mortgage loan amount. Home equity thus allows you to pledge your property to secure a loan. The implications are the same as a mortgage – if you default, the lender can sell your house for recovery. However, in addition, it allows you to obtain credit from an already pledged asset.

Auto loans: These are also a category of secured loans. Here the collateral is the vehicle that you have purchased. If you default in making the payment your vehicle might be ceased to recover the payment.

Student loans: As the name suggests, these loans are granted to students pursuing their education. Mainly two types of student loans are available in the US – private loans and federal student loans. In the year 2007 private loans accounted for 25 percent of all student loans in the US. These loans have higher limits but are more expensive than the federal loans. Federal loans offer students a grace period of six months for repayment after completing their graduation. Federal loans can be subsidized or unsubsidized depending on the need of the student. Until the student graduates the amount is paid by the government. According to the National Center for Education Statistics, about two thirds of American students have a loan amounting to $ 19237, on an average, after graduation. Of the two types of loans available, it is advisable to go for federal loans since their interest rates are lower and they come with a grace period of six months. However, there are limits on the amount that can be borrowed.

Payday loans: Also known as post-dated check loan, this is a short-term or emergency loan. This loan can be taken against your next pay check. This means you get to use the cash for an immediate need like car repair or a medical emergency before you get your next pay check. The lender is provided with a post-dated check that includes the amount borrowed and the interest applicable. Once your pay check gets deposited into your account, the lender withdraws the amount due to him. However, you must remember that a payday loan should only be used for immediate needs and is not an alternative to the other credit options mentioned above, the reason being the higher interest rates. Since the span of credit is short, the higher rate should not hurt you much. So as long as you make your payment on time, payday loans can be an effective way to provide for your immediate cash needs before you get your pay check.