While considering personal loans, people have to decide between a secured or an unsecured loan. As a real estate professional, you must understand the difference. The main difference between these loans is the presence or absence of collateral. Collateral is any object that has some value. Today we discuss the differences between secured loans and unsecured loans, define them, and more.
What Is A Secured Loan?
A secured loan allows you to obtain a loan against your property or assets. This loan requires you to offer collateral as a security to the lender. Collateral can include a home, car, plot of land, inventory, or other assets. In simple words, these loans are designed to protect the lender by using collateral just in case the borrower can’t repay the loan. Secured loans are mostly used for large amounts; thus, the lender needs collateral to reduce the risk. If the borrower can’t repay the amount, the lender takes the collateral that the borrower owns.
Lenders prefer these loans because they are less risky. On the other hand, borrowers prefer these loans because these loans usually offer lower interest rates and allow them to borrow more money.
You can use the following assets as collateral for a secured loan:
- Real estate
- Vehicles, including cars, SUVs, trucks, motorcycles, and boats
- Bank accounts
- Bond investments, mutual funds, and stocks
- Insurance policies
- Precious metals and stones, jewelry, and antiques
Types Of Secured Loans
The following are the most common types of secured loans:
Mortgages are the most common type of secured loans. These loans are used to buy homes, and the purchased home is the collateral. If the borrower defaults on the loan, the house will go into the lender’s ownership, and the borrower will lose the house.
Auto loans are available for buying cars, trucks, and other vehicles. In this case, the vehicle is used as collateral, like the home is collateral in a mortgage. When the borrower doesn’t repay the loan on time, the vehicle’s possession goes to the lender.
Secured credit cards:
Credit cards also work as collateral for secured loans. In this case, the borrower deposits cash in the credit card, which is collateral for the secured loan. You can deposit the amount according to your credit limit. When you don’t pay the loan on time, it is automatically deducted from the amount held as collateral.
Home Equity Line of Credit:
A Home Equity Line of Credit or HELOC allows you to obtain a loan against your home equity. Your home equity is the value of your home, excluding the amount you owe as a primary mortgage.
A secured loan has the following advantages:
- Lower interest rates
- Less risky for lenders
- High borrowing limits
- Longer repayment period
The following are a few disadvantages of a secured loan:
- Risky for the borrower (collateral loss in case of default)
- Fewer loan options
What Is An Unsecured Loan?
An unsecured loan allows you to obtain a loan without using any collateral. Instead of asking for collateral, the lenders check your credit history and ability to repay the loans from your previous records. Credit scores play an important role here, as the lender will consider it before offering you the loan. Unsecured loans are riskier for the lenders because if the borrower cannot repay the loan, there is no asset to recover the remaining loan amount. For this reason, lenders charge higher interest rates for offering unsecured loans.
When you apply for an unsecured loan, the lender ensures you can repay the loan on time. The lender evaluates your monthly income and financial resources. Once you obtain the loan, you can repay the amount in monthly payments to the lender and the interest rate. Thus, an unsecured loan uses the strength of your cash flow and creditworthiness as security instead of any physical collateral. This type of loan is more suitable for obtaining smaller amounts, such as $100k or less. Compared to secured loans, these loans have strict eligibility criteria, including the borrowers’ credit score and debt-to-income ratio. In case you fail to meet the eligibility requirements, you can still apply for a secured loan to obtain cash against any valuable asset you have.
Types of Unsecured Loans
The following are the common types of unsecured loans:
Personal loans are also called installment loans or term loans. These loans allow you to borrow from a few hundred dollars to tens of thousands of dollars. Personal loans can be used for any purpose, including home improvement, medical bills payment, trip financing, and more. These loans are available with a set repayment period, and you must make monthly payments consistently.
Loans are available for students free of collateral and don’t require a strict credit check. These loans help pay college fees and are available through private lenders and the department of education. Students can borrow an amount and pay their college fees and other expenses. However, this amount has to be paid back by the student once the studies are completed.
A credit card allows you to borrow funds from a bank to pay for products or services. These cards have different conditions for paying the borrowed money and the interest over time or on the billing date.
The following are the main advantages of unsecured loans:
- No collateral required
- Less risky for borrowers
- No risk to personal property
- Quick loan approval
The following are the disadvantages of unsecured loans:
- Higher interest rates
- Smaller loan amount
Secured Loan Vs Unsecured Loan Examples
Let’s say a person needs a loan to buy a house, and he approaches a lender who offers a standard residential mortgage. The cost of the home is $500,000, and the lender requires 5% of it as a down payment. In this case, the following will be the details of the mortgage loan he’s signing up for:
- $25,000 down payment
- $475,000 mortgage
In this case, the borrower is using a secured loan. The lender will register a lien on the property for the outstanding amount, which is $475,000. This makes the property act as collateral in the mortgage. Once the borrower repays the total loan amount, the property’s title is transferred to him.
Let’s take a look at an unsecured loan example. Let’s say there’s a person who wants to pay his medical bills but doesn’t have enough to cover the cost. He needs a loan for $30,000 and doesn’t own any property or assets that could serve as collateral. Luckily he has a credit score of 700. After chatting with a loan officer, he gets an unsecured loan to cover the medical expenses. He was able to get a personal loan for the loan amount of $30,000 with the following details:
- Loan amount: $30,000
- Loan term: 5 years
- Interest rate: 6%
- Monthly payments: $579.98
After the complete repayment of the loan, the total principal paid will be $30,000, and the total interest paid will be $4,799.04. Remember, personal loans come with higher interest rates because the lender takes more risk. But, in this case, the borrower got instant funding during the financial emergency, without the need to use any collateral.
Secured Loan Vs Unsecured Loan FAQs
What Are Real Estate Secured Loans?
Real estate-secured loans are specially designed for real estate transactions. They are also called hard money loans or bridge financing and offer more flexibility than conventional financing methods. These loans help those borrowers who may not qualify for conventional loans because of credit scores or income limitations. In such a case, bridge financing can help provide short-term loans until the real estate property is eligible for conventional financing.
When to Consider a Secured Loan?
A secured loan is a good option if you want a huge loan and have something valuable that you can offer as collateral. However, you must ensure that you’re comfortable offering your asset as collateral. In return, you’ll get the loan with a lower interest rate than the unsecured loan. A secured loan also helps build credit so you can later qualify for better terms if you need to get a loan from a financial institution.
Where to Get Secured Loans?
Secured Loans are available at banks, credit unions, and through online lenders. But you must remember that not all secured loans are the same, as they have different terms and conditions. Most traditional banks offer secured loans, including auto loans, mortgages, and home equity loans. On the other hand, credit unions have a fixed APR cap on most of their loans. Online lenders offer a convenient way to obtain loans; you can apply for a loan from the comfort of your home and prequalify a loan.
Are Secured Loans Available for Bad Credit?
Most lenders prefer a good credit score to provide a loan as it is less risky. However, a few lenders are ready to work with those with lower credit scores. Loans for bad credit are available at a higher APR, but they allow you to get emergency funds you need to fulfill your expenses.
What Are First and Second Mortgages?
First mortgages are the most popular real estate as they allow you to purchase or refinance a home. The amount you get as a loan is based on the value of your home (collateral) and your income. Second mortgages and home equity loans depend on your property’s equity. You can get a higher loan amount for a home with higher equity.
Which Type of Loan Is the Best?
After going through the advantages and disadvantages of secured and unsecured loans, you can better decide which type of loan is best. A secured loan is a good option if one has to purchase a large property without the best credit to purchase it through conventional loans. These loans have low-interest rates, so if the borrower has a stable income, repaying the loan is not an issue. Unsecured loans are a good option if the borrower has good creditworthiness and wants to avoid collateral. In the case of unsecured loans, default on loans doesn’t result in property loss, but it can negatively impact the credit score. On the other hand, if you default on a secured loan, you’ll end up losing your property.
What to Know for the Real Estate Exam
To sum it up, the loans that require collateral to back your loan are called secured loans. On the other hand, loans that don’t require collateral and just a credit check are called unsecured loans. The loans you get for purchasing a home or any real estate property are mortgages. The borrower signs a promissory note as evidence to pay the loan to the lender. While the lender takes the property as security, the property is free and clear of any lien when you repay the loan. A few common examples of real estate loans are first and second-mortgage loans. To learn more about real estate terms, check out our Real Estate flashcard app.