The Difference Between Unsecured and Secured Loans
There are several differences between an unsecured loan and a secured loan. The most important is secured loan’s required collateral, which is a valued item used to pledge fulfillment of the secured loan’s financial obligation. More simply, if a borrower is unable to pay their loan, the lender gets whatever collateral the borrower used to secure the loan.
Two common types of unsecured loans are personal loans and student loans. Lenders make unsecured personal loans based on the borrower’s credit history and his or her ability to repay the loan: employment history and current debt levels are their two most important factors. Student loans are sometimes large unsecured loans that are made to borrowers with no credit or employment history. They are specialty loans used to cover education costs and they are made on the borrower’s promise to repay them.
The two most common secured loans are home mortgages and auto loans. The collateral used to secure a home mortgage is the home. Typically, lenders require the borrower to make a down payment on the home to ensure they are not lending 100% of the home’s market value. The reason: if the borrower were unable to make his or her monthly payment the lender will legally seize or foreclose on the home, and the down payment will help the lender recover legal costs associated with the foreclosure.
When a secured loan is used to purchase a car, the car becomes the collateral. And if the borrower is unable to make his or her car payment, the lender will seize the car and sell it to pay off the secured loan’s remaining principle balance.