With innumerable financing methods, money lending apps, and easier ways of loan approvals from banks and financial institutions, it is important to be familiar with two terms associated with debt — secured and unsecured loans.
Loans are mainly categorised as secured and unsecured, based on one prime difference — the presence or absence of a collateral. Collaterals are assets that act as a security to the debt or loan if you fail to pay or default. These collaterals can range from property to stocks or bonds. Mortgages are an example of secured loans — it is an asset-backed loan given usually based on the creditworthiness of the borrower. An unsecured loan, on the other hand, is credit cards limits of which are set against your salary/repayment capacity.
How do secured and unsecured loans matter?
One of the most commonly asked questions is if it matters whether a loan is secured or unsecured. Yes, it does. Your borrowing limit, the duration for repayment, terms & conditions, and in most cases, even the rates of interest differ based on the kind of loan it is.
Secured loans have some advantages over unsecured loans:
– Lower rates of interest
– Higher borrowing limits
– Longer repayment terms
Sanjay Kathuria, director at Bada Business, a platform that develops business strategies for SMEs, says, “It’s about requirements for borrowers and risk-return ratio for lenders. Borrowers will prefer secured loans for low rates of interest. They opt for unsecured loans lest they have collaterals. New apps that offer quick unsecured loans have higher interests and they see what returns they get in a certain number of EMIs”.
What happens when you fail to repay your loan?
Defaulters ruin their credit score and credit history in either case, which will make lenders think twice before extending credit to them in future. However, in case of secured loans, your pledged assets are seized to recover the dues. The lender has the right to possession of your collaterals as per agreement.
On the other hand, a legal course of action may be taken when you are unable to pay off unsecured loans. If the decision is against you and if your assets are used for repayment, you end up losing your possessions, credit score, plus run the risk of lawsuits, collections, and civil judgments against you.
Radhika Binani, chief product officer of Paisabazaar says, “Credit risk for lenders are lower in case of secured loans as the lenders can sell the underlying collateral in case borrowers fail to honour their repayment commitments. Hence, the interest rates of secured loans are lower than unsecured loans. Similarly, lenders lay less emphasis on credit score while evaluating applications for secured loans, especially those backed by relatively more liquid assets. Hence, those having poor credit scores or credit profiles should opt for secured loans. Those having insufficient assets to submit as collaterals for secured loans have no option but to opt for unsecured loans.”
Secured vs Unsecured loans — which one should you pick?
While secured loans have certain benefits over unsecured ones even when you default, there are few things upon which you must base your decision:
- Monetary Requirements: Unsecured loans carry more risks for lenders, so there are chances of not being lent huge amounts, so you have to opt for secured loans.
- Collaterals to be pledged: Your comfort with the assets you want to risk matters a lot. If you don’t want to pledge any collaterals, unsecured loans are the way out.
- Repayment deadline: Secured loans always have longer repayment terms. So if you can’t choose to repay in a short time, opt for secured Loans
- Terms & Conditions – Other T&Cs are important when taking a loan and these can mean different things to different people based on credit score, employment history, salary, etc. For instance, credit card loans are the most expensive ones. If you take a credit card loan (unsecured) of Rs 4 lakh, you might end up paying Rs. 1.5 lakh or more annually.
If you borrow judiciously, repay timely, and can well define your needs and financial expenses, then both secured and unsecured loans could work for you. Ultimately, your requirements dictate the loan you should opt for.
All images: Courtesy Getty