A secured loan requires the borrower to provide an asset to stand as collateral for the loan. The asset is in most cases property or a vehicle. If the borrower defaults on his/her payments - they don't pay on the agreed upon time - the lender is entitled to take the asset that was put as collateral and sell it to redeem the value of the loan.
Benefits of a secured loan
- Allows the borrower to access a loan at cheaper interest rates and over a more favourable term. This is because the risk of lending to you decreases.
- For the lender, it allows the lender to lend you money with minimal financial risk. If there is a default in payment they sell your asset that stands as collateral to pay off the outstanding balance.
When lenders talk about an unsecured loan, they refer to a loan that needs no asset to stand as collateral. This means that you are able to receive a loan without owning an asset. In the event of a default on your monthly instalment, the lender cannot take your house or vehicle to retrieve the outstanding debt amount. The recourse they can act upon is going through legal procedures in order to regain the outstanding money. These lenders base their decision primarily on your credit score and income. Due to the fact that unsecured loans carry more risk for the lender, their lending terms are less favourable than secured loans.
Benefits of an unsecured loan
- You do not need an asset as equity against the amount you are lending. Which is the case for many lower income earners.
- Due to you not needing an asset to stand against your loan amount, not owning a property or vehicle will not stand against you when applying for a loan.
As you can see, there are simple, yet substantial differences between secured loan and unsecured loans. They each have their advantages and disadvantages. A secured loan might offer more favorable lending terms whilst an unsecured loan is quicker and easier to attain. A person can often receive a more favourable secured loan than an unsecured loan as there is less risk of the lender not being able to receive the outstanding loan amount.