What You Need To Know About Secured & Unsecured Loans
When a borrower applies for a loan, the lender relies on its application and underwriting process to determine whether the customer presents an acceptable credit risk. Depending on what the lender determines, the borrower might qualify for a secured or unsecured loan. But what are secured and unsecured loans?
Secured loans are a type of loan wherein an asset with marketable value is pledged by the borrower to the lender as collateral. The security is defined in the loan agreement or contract, and it describes the planned disposition of the collateral should the loan go into default.
For most lenders, secured loans are considered less risky than their unsecured counterparts. If the borrower defaults on a secured loan, the lender can use the collateral to recover the loan funds and minimize their losses. Because of this lowered risk, secured loans are usually easier for borrowers to qualify for. Auto loans are one of the most common forms of secured loans.
Other common types of secured loans are mortgage loans, business loans and pawn loans.
The lender may choose to establish a repayment agreement to help a borrower catch up if they fall behind on payments, but the lender may not be obligated to do so. If the borrower falls behind, the lender may seize the collateral. Typically, the borrower will be granted a period of time to catch up on the past-due amounts and get their collateral back, but if they fail to do so the lender may sell the collateral to a third party and use the sale proceeds to pay off the loan balance.
Unsecured loans, on the other hand, do not require any type of collateral from the borrower. Because unsecured loans pose greater risk for the lender, they are typically more difficult to qualify for than secured loans. Student loans, signature loans, payday loans, cash advance loans and credit card cash advances are all examples of unsecured loans.
While most unsecured loans do not require collateral, some nominally “unsecured” loans may actually use wage garnishments as a type of security. In these cases, the lender or creditor may have the right to garnish the borrower’s wages in order to satisfy the loan balance. Although physical collateral may not be used as security, if a borrower fails to repay the loan, their credit ratings could be damaged, resulting in long-term negative effects. The lender can also begin loan collection attempts.