Lending money to consumers is a profitable market that has been around for a very long time. There are different types of methods financial institutions use to determine who can get a loan. They also determine how much someone can borrow and the terms for which it is paid back.
There was a time when people with poor or bad credit were shut out of traditional banks and lending opportunities. As people incurred more debt and the economy changed, it became increasingly hard for them to repay the money they owed.
Secured debt has always been a part of the lending structure. Home mortgages and car loans are two popular categories. To address the needs of the working class with less than perfect credit, new forms of secured debt options became available.
These financial opportunities fill a gap but they also come with pitfalls.
Are you looking for a loan but don’t fully understand the difference between secured loans and unsecured loans? Keep reading to learn the pros and cons.
Secured Debt vs. Unsecured Debt
The difference between secured debt and unsecured debt is one requires collateral and the other one doesn’t. Sometimes a borrower’s credit score plays a part in whether a loan has to be secured.
This is an important factor when it comes to borrowing money for personal loans. The lender wants an assurance that the borrower will repay the money.
With unsecured debt, the lender runs the risk of not being able to recoup their losses. This is why they only lend to people with a track record of repaying their debt.
Types of Secured Loans
There are various tyles of secured loans. Some of them are secured because they allow consumers to make major purchases.
Let’s look at examples.
Mortgages
Mortgages are secured by the property being purchased. If the borrower defaults the lender will foreclose on the home, building, or land.
Car Loans
The vehicle you’re purchasing secures the loan. People with good credit have a greater chance of being approved for a new car. Poor credit means a used vehicle purchased at a buy here pay here car lot.
Payday Loans
Payday loans require an agreement to allow the lender to withdraw funds from your bank account to repay the loan. A pawnshop will require something of value like jewelry to secure the loan.
Title Loans
If you hold the legal title to a vehicle, it can be used to secure a loan. There are maximums you can borrow and other conditions. To learn more, visit Southwest Title Loans.
Annuity Loans
These are loans you can make against money that is owed to you in the future. An example would be money from a lawsuit or your inheritance.
Secured Credit Card
A secured credit card is an extension of credit based on a financial deposit. It is marketed as a way to rebuild credit.
The Purpose of Collateral
The sole purpose of collateral to back secured loans is to add a level of insurance that the borrower will repay the money. Collateral is an item of value used to secure debt and provide the lender with a level of protection.
Lenders are not in the business of taking possession of the personal property and reselling it. They want the borrower to repay the money loaned.
Understanding the Terms and Conditions
It is important for borrowers to clearly understand the terms and conditions of a secured loan. In them, they will understand the terms for which holds or leans are removed from the collateral.
Defaults are defined and the penalties.
The terms and conditions also show the interest rates, months to repay, monthly amounts, and potential late fees. Do not sign the loan documents if you do not fully understand the contract.
Does it Improve Your Credit Score?
In most instances, secured debt improves your credit score when it is repaid on schedule. On the reverse side, not repaying the debt will adversely impact your score.
The only time secured loans will not have any impact on your credit score is when the money is coming from a non-traditional lender.
Pros of Secured Debt
There equal pros and cons of secured debt. The pros always start with the fact that secured loans allow consumers to make purchases with the extension of credit.
Other pros include:
1. You can buy big-ticket items like a house or car. Most people do not have the money to pay cash for things that cost 10s of thousands of dollars. With a secured loan these purchases can be repaid over five to 30 years.
2. When you have good credit, a secured loan can mean lower interest rates. Although you can still get the money you need with less than perfect credit, you will have a higher interest rate to offset the risk.
3. Repaying a secured debt on time will help build your credit-worthiness. Homes and cars will always require collateral, but paying on time will have a positive impact on future purchases. Plus, it provides new unsecured credit opportunities.
Cons of Secured Debt
Wherever there are pros there have to be cons. The con of secured debt rest in the hands of the borrower.
1. The biggest con of secured debt is if you do not honor the terms of the contract you will forfeit the collateral. This can be a costly and embarrassing turn of events that involves lawsuits, evictions, and your car being towed without notice.
2. Failure to satisfy the conditions of your loan will make it difficult to make future large purchases. You’ll face higher interests if you are able to get credit at all.
Do You Need a Loan?
Secured debt is one way to get the money that you need. As long as you understand the consequences of not repaying the loan, you should be okay. Only borrow an amount you are able to repay.
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