A loan is called a forbearance agreement. Forbearance means one person, the creditor, pays in your behalf or forwards money to a borrower. The latter then promises to pay the principal amount due plus interest on an instalment basis. There is two types of loans namely secured & unsecured loans.
This article will discuss the difference between secured & unsecured personal loans. Along the way, important tips will also be provided. For more details, read related articles from the same author/website.
Personal Loan Defined
A personal loan is when an actual person, not a juridical person, takes out a loan from a bank or financial institution. The example of the former is you and me. Examples of the latter are corporations, partnerships, agencies, etc.
Strictly speaking, the amount borrowed is for personal use. This means that the borrower actually receives cash or a revolving credit involving a certain amount. This is as opposed to business, home, auto, insurance, etc.
Realistically speaking, for so long as the amount is enough, there is no stopping a person from using a personal loan to buy anything, i.e. a car or a house even. The utilisation of which depends on the borrower. This is as opposed to a home loan or auto loan wherein the borrower does not get a chance to hold the loaned amount because the lender directly sends it to the seller.
A secured loan is called such because of a security arrangement known as collateral. In the event that the borrower cannot pay, the lender can either take back ownership of the collateral or take possession and auction it off. The proceeds will then be applied to the outstanding loan. By default the property that an applicant buys with the loan is collateral. Collateral can also take the form of a post dated check, or another property that is easily marketable.
As a general rule, secured loans involve a higher amount of money than unsecured loans. This amount is relative to the individual’s income. For example, a millionaire will be able to get a higher personal loan than say the average salary man earning regular wage.
Relatively speaking, secured loans have lower interest rates than unsecured loans. For example, a personal loan with collateral can cost you 24% Annual Percentage Rate. But a payday loan can cost you around 60% Annual Percentage Rate.
Secured loans usually involve loans that are payable in several months to several years. For example, you were able to use your personal loan to buy a second hand automobile. This may require you to pay anywhere from 6 months to 48 months. On the other hand, an unsecured payday loan only requires you to pay 1 or 2 instalments, 6 at most.
Collateral vs. Income
Secured loans usually has a mortgage clause especially when a person buys a house. An unsecured loan does not have collateral. Hence, the lender is basing the loanable amount on some other thing. The most common basis is a percentage of the salary vis a vis instalment payments.
It All Boils Down To Risk
Secured loans utilise the collateral to minimise the risk of default. If the borrower cannot pay, they can foreclose on the collateral. This puts a lot of pressure on the borrower to make payments. Unsecured loans utilise high penalties and compounded interest to dissuade borrowers from not paying. Statistically speaking, unsecured loans pose a bigger risk of non-payment, hence the higher A.P.R.