For most people, loans are a fact of life. Whether car loan, mortgage, college loan, or personal loan, everyone needs money for big purchases or debt consolidation every now and then.
The financial world breaks loans down into two categories: unsecured loans and secured loans. Which loan type the debtor chooses depends on his or her financial circumstances. For example, a homeowner who seeks debt consolidation may elect a secured debt consolidation loan to pay down his or her debt.
What Are Unsecured Loans?
An unsecured loan is any loan that is not backed by an asset (collateral). The most common unsecured loan is a personal loan for use in situations such as college tuition, medical expenses, or to pay down other debts.
Unsecured loans are based primarily on the debtor’s credit rating. They generally carry less risk and are cheaper than secured loans. However, unsecured loans can sometimes prove difficult to qualify for if the debtor’s credit rating is less than stellar.
What Are Secured Loans?
As opposed to unsecured loans, a secured loan is any loan that is backed by collateral. Mortgages and car loans are prime examples of secured loans. The debtor pledges the asset against the secured loan until the secured loan is fully amortized.
Unlike the unsecured loan, secured loans are based not simply on the debtor’s credit rating but also on income. Secured loans carry more risk then their unsecured counterparts, and they are more expensive. Yet at the same time, secured loans are generally easier to qualify for because they factor in income as well as credit rating.
The downside to the secured loan is the risk that the creditor could take possession of the asset in the case that the debtor falls behind on monthly payments. The recent upswing in home foreclosures is a prime example of creditors repossessing homes from debtors who could no longer afford their mortgage payments.
Car repossessions are common as well when debtors can no longer afford their monthly car payments. In this case, the creditor takes over the secured loan and seizes the asset. It is not uncommon for a car to be repossessed right out of the debtor’s driveway in the middle of the night.
Where to Find Unsecured Loans or Secured Loans
People who need a loan can find both unsecured loans and secured loans at their lending institution or online. Popular financial websites include E-Loan, LendingTree.com, and Bankrate.com.
Another loan option for those who have incurred debt is the debt consolidation loan. Debt consolidation loans combine debts such as college loans, credit card balances, and personal loans into one manageable loan package.
Debt consolidation loans can take the form of either a secure loan (e.g., home equity loan, cash-out refinance, auto loan refinance) or an unsecured loan (e.g., personal loan).
In summary, the most common type of loan is the secured loan which includes car loans, mortgages, or other loans where collateral is pledged by the debtor.
While the secured loan is more expensive and carries more risk, the unsecured loan is used in cases where the loan is not backed by collateral such as a college loan or personal loan.
Ultimately, the type of loan selected by the debtor is dependent upon the debtor’s financial status and tolerance for risk.