Australia’s household debt has surpassed $2.46 trillion. It’s a 200 percent debt to income ratio, making Australia second only to Switzerland in terms of household liabilities worldwide.
The massive household debt reveals how essential credit is for Australians. Even for the 35.7 percent of Australians who are financially secure, loans play a huge role in paying for many of life’s expenses, including education, homes, renovations, business expenses, and many more.
Generally, loans can be divided into two major categories: secure and unsecured. Today, we focus on the secured loan vs. unsecured loan conversation. We’ll outline the main differences between the two, as well as which of the two you should opt for.
Read on to learn more.
What Is a Secured Loan?
A secure loan refers to a type of loan that is backed by collateral. The collateral can be any financial asset the borrower owns. If the borrower doesn’t pay back the loan, the lender can seize the collateral as payment for the loan.
Note that a repossession typically stays on your credit report for years, so it’s best to avoid it as much as possible. There are specific rules against repossession, though. For instance, lenders in Australia cannot repossess your item without a court order when you owe less than 25% of the loan.
Once you take out a secured loan, your lender immediately puts a lien on the asset offered as collateral. As soon as you’ve paid off the loan, that lien is removed. You thus get to own both assets now, free and clear.
Some of the commonest assets Australians use as collateral include real estate, vehicles, bank accounts, stocks, high-end collectibles, and insurance policies.
Some popular examples of secured loans include:
A mortgage refers to a loan that you use to purchase a home or some other form of real estate. Mortgages can also be used for maintaining your property. The borrower agrees to pay back the loan over time, usually in a series of regular monthly payments.
In mortgages, the property acts as the collateral used to secure the loan. If you’re unable to repay the mortgage, your house can go into foreclosure, and you may lose it.
Also known as vehicle loans, auto loans are available for purchasing cars, trucks, boats, and motorcycles. Performing a car loan comparison can help you identify the ideal car financing solution for you.
In auto loans, the vehicle functions as collateral. That means the lender can repossess the vehicle as repayment if you’re unable to repay the loan.
Secured Credit Cards
A secured credit card refers to a type of credit card where a cash deposit made by the car holder serves as collateral. That means in case you fail to make payments, your lender can take money from the cash they’re holding as collateral.
Secured credit cards are especially useful for borrowers whose credit history is limited. They offer the borrower an opportunity to build their credit score.
What Is an Unsecured Loan?
An unsecured loan refers to a type of loan where the lender doesn’t require any collateral to give out the loan. Instead, the lender relies on your creditworthiness. Note that you still have to pay fees and interest on the loan.
In most cases, unsecured loans tend to have higher interest rates than secured loans. Borrowers can take out personal loans for just about any purpose, including renovating their property, paying for dream vacations, paying off credit card debt, and much more.
Some examples of unsecured loans include:
A personal loan refers to a type of credit you can use for various purposes, including making big purchases. These loans are often referred to as instalment loans and term loans. That’s because their repayment time is usually fixed, and the payments are typically made in equal amounts and monthly.
Given that personal loans tend to have a lower interest rate than credit cards, many borrowers use them to consolidate their credit card debts into one, lower-cost monthly payment.
Student loans are loans specifically designed to help learners pay for post-secondary school education. You may use the loan to pay for college fees, including tuition, books, supplies, and living expenses.
Generally, borrowers have little credit history and few assets, if at all.
Revolving loans are a form of credit that allows the borrower to draw down or withdraw repeatedly. Popular examples of these loans include personal lines of credit and credit cards.
What Are the Main Differences Between Secured and Unsecured Loans?
Now that you know what secured and unsecured loans are, it’s time to look at the areas in which the two differ. Here are six of them.
A crucial difference between secured and unsecured loans has to do with collateral. You cannot get a secured loan without collateral, such as a car, a piece of property, or even money in your credit union share account. Your lender puts a lien on the asset used as collateral until you’ve paid off your loan.
By contrast, unsecured loans require no collateral. Instead, they’re based on your creditworthiness.
Typically, unsecured loans have higher interest rates than secured loans. This makes perfect sense, given that a lender takes a more significant risk when giving out an unsecured loan. Borrowers with a stellar credit score and an impressive payment history generally qualify for friendlier interest rates when borrowing unsecured loans.
Generally, the borrowing limit is higher for secured loans than for unsecured loans. Note that this depends on the collateral you’re using for the loan, as well as the specific lender you’re working with.
Ease of Qualification
Secured loans tend to be easier to qualify for than their unsecured counterparts. That’s why borrowers with shaky credit or without much credit history opt for secured loans.
When it comes to unsecured loans, lenders keenly scrutinize your credit score, your existing debt, and your income. Only when they’re satisfied with what they see will they approve you for a loan.
Risk to the Borrower
A secured loan is arguably much riskier than a secured one. That’s because if, for some reason, you’re unable to repay your loan, you can lose the collateral you used to borrow the funds.
Restrictions on Loan Use
When applying for a secured loan, the lender approves the loan for a specific purpose. It may be for purchasing a home, a vehicle, a piece of real estate, and so on. Thus, your options on how to use the funds tend to be limited.
Conversely, unsecured personal loans can be used for almost any purpose. Provided that you aren’t using the funds to gamble, buy securities, or conduct illegal activities, you’re free to use the money as you please.
Secured Loan vs. Unsecured Loan: In Short
The secured vs. unsecured loan decision ultimately comes down to a variety of factors. Getting a secured loan is a lot easier than getting unsecured financing. Thus, borrowers with less than stellar credit history or who are looking to rebuild their credit can benefit from this type of loan.
Secured loans also tend to have more affordable interest rates. For this reason, it’s the better option when you’re keen on money management. The amount you save on interest can be significant, depending on the size of the loan and the term.
For those looking for a large amount of money, secured loans may also be ideal. That’s because these loans typically have a larger borrowing limit, which means you have access to more money.
But unsecured loans may be more appealing to borrowers who are interested in financing that is more risk-free. Since there’s no collateral involved in an unsecured loan, you needn’t worry about losing your asset if you can’t continue making payments for some reason.
Unsecured loans also grant you the freedom to spend the funds however you wish, provided it’s legal.
Choose the Right Loan Type for You
Now that the secured loan vs. unsecured loan discussion is much clearer to you, it should be easier to know which of the two suits you best. Simply weigh the benefits and drawbacks of each, and go with the option that suits your situation and financial need best.
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