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Whether or not a loan is secured or not by collateral, there are two types of loans – secured and unsecured loans.
Secured Loans
What is it?
This type of loan is secured by collateral, which can be an asset or property you own. If you miss payments or default on the loan, the lender has the right to place a lien on the collateral. Common examples of collateral include assets like a home or a car that you purchase with the loan.
Pros & Cons
These types of loans offer some of the best options on the market such as lower interest rates and higher borrowing limits. Moreover, the term of the loan has the potential to be much longer than what unsecured loans offer.
The most serious consequence of this type of loan is that if you fail to repay the loan, the lender has the right to confiscate your collateral. It’s a bad ordeal when your car or home is on the line. Remember to be careful and always pay your monthly payment on time.
Example of Secured Loans
- Mortgages are loans that lenders give to individuals so they can buy property. In this case, the collateral is real estate. People can choose from many options to choose from. They have the option to have a fixed rate, ARM mortgage or a combination of both.
- An auto /car loan is what a lender gives an individual wants to buy a car whether new or used. In this case, the collateral is the car.
- People can take out a recreational vehicle loan if they want to purchase a recreational vehicle.
- Some people may want to buy a boat; they have the option to apply for a boat loan.
- Obtaining a Home Equity Line of Credit (HELOC) is like having a second mortgage. The buyer’s property, once again, is the collateral. Check it out with an advanced HELOC calculator.
Unsecured Loans
This type of loan has no security at all; this means that there is no collateral. Credit cards, student loans, and personal loans are examples of this type of loan. If the borrower fails to pay back their debt, the lender has nothing to fall back on for compensation.
As a result, these loans are not appealing because they carry more risk.
In many cases, lenders may not approve an unsecured loan, but don't be discouraged—if you need the funds, consider applying for a secured loan instead.
Lenders often refer to secured loans as signature loans since the borrower's signature is the only collateral they have. Before approving this type of loan, banks typically evaluate two key factors.
- Credit
The lender has the right to access your credit history. What they are looking for is your previous debt and also whether or not you missed payments in the past. After the lender reviews your credit history, then they will have more clarity on your credit score. This will also determine your interest rate.
- Income
Evaluate whether or not you can really afford the loan you are requesting. Your lender will definitely make sure of it. The lender requires to see your proof of income and will calculate the debt-to-income ratio, which is a big deciding factor on the lender’s part.
Example of Unsecured Loans
- A credit card is the most common type of unsecured loan. A credit card gives an individual the opportunity to use the line of credit anytime he or she needs it.
- Personal Lines of Credit offer the same benefit as a credit card. You can use it anytime you need to.
- Personal (Signature) Loans are unsecured loans that are used for average, general purposes.
- Student loans cover fees accumulated from college in order for an individual to acquire an academic degree.
- Home Improvement Loans are personal loans that people use to cover expenses related to improving their home.
Open-ended Loans
The answer is in the name. These loans have no specific date of repayment, which means you can borrow as many times as you like.
Do you have a credit card or a line of credit?
If so, then you are an active holder of an open-ended loan.
Moreover, this type of loan does have a limit regarding the maximum amount you can borrow at one time.
Close-ended Loans
This is a fixed type on; the borrower can’t modify the term of the loan nor the number and amount or number of their monthly payments. With this type of loan, you can’t borrow the amount again. Mortgages, student loans, and personal are all examples of close-ended loans.
A word of caution:
A major setback is that we can conclude that you don’t have any credit readily available when you need it the most. You will have to get a new loan or refinance an existing one.
Furthermore, if you want to modify your contract, the lender has the right to apply penalties and new fees. Nonetheless, this type of loan is good for purchases such as buying a house, car, etc.
Conventional Loans
Conventional loans aren’t insured by a government body such as the Federal Housing Administration (FHA), the Veterans Administration (VA) and the Rural Housing Service (RHS).
The two types are usually conforming or non-conforming. The former are mortgages that follow the requirements of Fannie Mae and Freddie Mac. The latter is not bound to the limits that are placed by the two government agencies.
According to 2014 statistics, the data show that 57% of homebuyers chose to purchase property with a conventional loan.
