Be it for a personal reason or business purpose, capital funding can take care of your financial needs and with several lenders offering favourable terms, getting loans has gotten easier over the years. However, a smart borrower is one who is well informed. It takes only a little research to understand what choices you have as a loan applicant. Though there are different types of loans, most of them can be categorized into secured and unsecured loans. Below we highlight some of the key differences between the two types of loans.
Secured Vs. Unsecured
Secured loans are the loans that come with some kind of guarantee or security. When a borrower gives an asset as a guarantee, it decreases the risk factor for the lender. This asset is called collateral in banking parlance. It can be anything from your real estate property, car, gold jewellery, to fixed deposits - something valuable that the lender can sell to recover his money, in case you fail to repay the loan. On the contrary, the loan that involves no collateral is called an unsecured loan. This type of loan is issued based on the borrower’s creditworthiness.
The presence of collateral fetches the applicant better loan terms. Therefore, the interest rate charged on secured loans is lower than unsecured loans. The lenders mitigate their risk in unsecured loan by levying heftier interest rate and earning more returns. The processing fee for unsecured loans is also higher.
Similarly, the reduced level of risk in secured loans, allows the lenders to sanction bigger loan amounts. Despite the bigger interest rate, lenders are always concerned about the possibility of defaults in case of unsecured loans and therefore, sanction a smaller amount to be on the safer side.
To reiterate, secured loans are the ones, which are sanctioned on putting an asset (collateral) on line. The lender holds the title/deed of your collateral until you repay your loan in full. Those who do not own any such collateral or do not wish to give security can opt for unsecured loans.
In secured loans, the borrower is always under pressure to make timely repayments to make sure his/her asset is protected. However, when there is no asset on stake, there is no risk of losing your collateral. Therefore, in case of loan default, the borrower can retain his property in unsecured loans. If you are not able to make your payments, the lender will approach the co-signer/guarantor for paying back the loan or ask collection companies to recover the loan.
As mentioned above, secured loans offer the least risk to lenders as they can always recover their money by selling the collateral pledged. However, the lender’s risk in unsecured loans is bigger as the borrower may fail to repay the amount loaned and lenders may have to take the legal course to recover their money.
In both cases, better the credit history better will be the terms. However, the eligibility criteria for unsecured loans are more stringent. The applicant’s creditworthiness is judged on his/her monthly income, the stability of job or business, credit score and income-debt ratio among others followed by rigorous documentation and verification process. In secured loans, the value and proper ownership of the collateral matters more.
Secured loans have longer repayment tenures up to 30 years but unsecured loans have to be repaid within a few years.
Loan against property, home loans, home equity lines of credit, car and bike loans, machinery loan, and invoice financing are types of secured loans as the land, vehicle, machine and invoices act as collateral. Similarly, credit cards, personal loans, and student loans are examples of unsecured loans.
Which is better?
Experts suggest borrowers go for secured loans, as it is easier to get. A person with a poor credit score can avail a secured loan if he/she has valuable collateral to pledge. In addition, the borrower gets the benefit of favourable terms. However, a default will lead to a loss of collateral. For those who do not want or cannot risk putting an asset on the line and are quite confident about their repayment ability can opt for an unsecured loan for smaller amounts. These loans have strict eligibility criteria and loan terms are less favourable than secured loans. However, with no collateral at stake, the borrower does not stand the risk of losing an asset. Those who want bigger amounts with longer tenures and own an asset can apply for secured loans. To finance the immediate needs of smaller scale, opt for an unsecured one.
To conclude, there is no definitive answer to the question - ‘which loan is better?’. One must act according to his/her own financial situation. However, before that, the applicant must know what separates one from the other. For borrowers, taking the minimum loan amount required and repaying it quickly should be the ultimate aim irrespective of the type of loan.