When you get a loan, it can fall into any of the two categories known as secured loan and unsecured loan. It is very important to know what type of loan you are applying or have acquired, so that you can better manage your debt portfolio and develop a plan to pay it faster or at a lower cost. In this post, I will discuss both types of the loans.
Secured Loan : It is granted with a guarantee or collateral backing, so that if the debt falls into arrears, the lender can repossess or take possession of the asset that you have designated as collateral. The same will later be sold, so that lender can recover the borrowed amount. In case the money raised from the sale does not repay the entire debt, the lender will invoice you the difference.
Mortgages are an example of this type of loan. In this case, home is the collateral of the loan and if you stop paying, the lender will start a foreclosure process.
Another loan that falls into this category is the loan for the purchase of car, in which the vehicle is the collateral of the loan. If you stop paying, the vehicle can be repossessed by the concerned party.
Business loans can also fall into this category. In the majority of cases, loans are backed by inventory, machinery, equipment or other business assets.
Another example is secured credit card, which uses money deposit as collateral. This is a good way to start establishing credit.
Because there is a collateral for payment, and the debtor has much to lose if he/she falls into arrears like home or car, these loans have a lower interest rate because they represent a lower risk for the lender.
Unsecured Loan : This type has no collateral for payment, therefore, in the case of default, the lender cannot take any asset to recover the borrowed amount. Failing that, the lender may take other options such as using the services of a collection agency, or go to court to order the attachment of borrower’s salary or other assets until the debt is cleared.
Debts for medical bills and services such as gas, water, or electricity fall into this category. In addition, credit cards, personal loans and student loans also come in this category. The students can get this type of loan and learn more about essay help at QualityEssay.co.uk.
Because of the fact that you do not have any kind of asset as a payment guarantee, this type of loan represents a high risk for the lender, so the interest rate is higher. You can have a look at the interest rates of different credit cards offered in the market, especially those offered in department stores. While it is true that this type of debt can be extinguished if you file for bankruptcy, you will have trouble accessing a loan for the next 10 years.
Effects of Loan Type on Your Credit Score : Only 10% of your credit score is determined by the diversity of debt in your portfolio, that is, by a balanced combination of revolving credit cards (unsecured), and term loans such as car loans (secured). So this should not worry you since the most important thing in your credit score is the payment history and level of indebtedness and between them they represent 60% of your score.
Setting Priorities : If at any time you go through financial problems and you have to decide between paying the secured debt and the unsecured debt, it is better to prioritize the secured debt as many assets such as your home or car may be in play.