Gone are the days when the access to valuable resources and possessions only belong to the wealthy and high-earning folks. Today, you don’t have to wait for years of striving hard and saving more before you can buy a home, a car, or even the simplest necessities in life. Several financial institutions have come up with various solutions to cater to the need of people who can’t wait to enjoy the best of life today.
Buy now, pay later – this is the main principle of loans. A loan is a process of lending a sum of money from an individual or organization like banks and credit union to another entity. The borrower receives an amount of money simply called the “principal” from the lender which should be paid off with an interest rate at a specific period of time set forth in the agreement.
Different needs, different loans. There are long-term loans which have a more flexible and longer payment term. There are also short-term loans to give aid to immediate borrowing solutions. Despite the growing number of money lenders, loans only fall into two categories: secured loan and unsecured loan.
Secured Loans And Unsecured Loans
What are the differences?
- Defining secured and unsecured loans
A secured loan is a loan secured by a collateral. A lien is placed on the borrower’s assets or properties and the financial institution takes hold of the title or deed until the debt is paid off. In secured loans, the individual can borrow large amounts of money. Given that there’s a valuable property at stake, the lender is assured that the borrower will do everything in his power to repay what he owed.
An unsecured loan caters to borrowers with short-term needs of smaller amounts. Unlike in a secured loan, the unsecured type is obtained without the use of a property or an asset as a collateral. These loans are supported only by the borrower’s creditworthiness. In most cases, these loans are ideal for emergency situations and personal home issues.
- Breaking the comparisons down
As discussed earlier, collateral is one of the factors that differentiate secured and unsecured loans. In a secured personal loan, the lender places a lien on your assets such as your home, car, and investments to be used as a collateral.
In the event that you default on your payments, the lender will take and sell your assets to repay what you owed. If you manage to stay consistent with repayments as set in the agreement, you may ask the lender to release the asset and hand you a clean, lien-free title.
In an unsecured loan, the financial institution has no access to any of your assets. However, the advantage of not putting an asset as a collateral may also be considered a huge disadvantage.
If you fall behind on repaying the loan, the lender may take other actions to get back their money. The lender may commission a debt collecting agency to persuade you to pay your debt. If this action didn’t work, your lender may sue you. If the court rules are in favor of the lender, they may garnish your wages, freeze your accounts, and take possession of your assets until you’ve paid your debt. In addition, they also have the power to harm your credit rating by reporting your delinquent behavior to the credit bureaus.
Even though it’s just a short-term loan whose amounts are quite lower, it is not easy to get qualified and approved for an unsecured loan. Approval is primarily based on your credit history and reputation. Some banks and lending institutions also look at their established relationship with the borrower before engaging into an agreement or extending the loan.
With a secured loan, impressive credit history is always ideal but not compulsory. The approval of the loan is based on the value of your property. The asset to be used as a collateral needs to be appraised first by the financial institution before setting the terms of the loan.
Lenders won’t engage in a business where they have nothing to gain. The key is the higher the risk to lenders, the higher the interest rates given to borrowers. Unsecured loans have higher, fixed interest rates since the lenders have no collateral to hold in the event the borrower defaults.
Secured loans are backed by large assets as collaterals. With this, the consumers are considered low-risk and they have lower interest rates which are often flexible.
Borrowing limits and terms of the loan
If you’re in need of a small amount of money with faster transactions, unsecured loans may be the best way to go. The repayment term of these loans also tends to be shorter. Unsecured loans can either be a revolving loan, where you have a credit limit to be spent, repaid, and spent again, or a term loan, which you can repay in equal installments in a specific period of time. The principal as well as the interest rate is fixed, making most unsecured loan types have a shorter repayment period of 5 to 6 years.
The borrowing limits for secured loans, on the other hand, are usually higher. Since the repayments are more flexible, the term tends to be longer. The repayment terms of secured loans, particularly those secured by real estate, can take up to 30 years.
Different Loans And Different Needs
Common Types Of Loans And Their Uses
- Secured Loans
A mortgage is a popular type of secured loan used to purchase a real estate property. This loan is ideal for buyers need to acquire immediate funds to purchase a home, building, or any property up front. It can also be used by existing property owners to obtain money for any purpose while putting a lien on the property being mortgaged. If the borrower falls on the repayments of the mortgage during the term, the bank can foreclose the home or property.
Home Equity Loan
A home equity loan is a type of loan in which the borrower uses the equity of his or her home as a collateral for a fixed amount of money. The amount to be borrowed is based on the value of the property and is determined through a valid appraisal by the lending institution. In this type of loan, the borrowers agree to repay the loan over a fixed term with equal monthly payments. Similar to mortgage loans, the lender may foreclose on the home if the borrower fails to keep up with the repayments.
Home Equity Line Of Credit (HELOC)
Home equity line of credit is quite similar to credit cards wherein the borrower is entitled to a line of credit which can be used for any purposes as needed. But since it’s a secured loan, the borrower’s equity in his or her home shall be used as a collateral for the loan. In HELOC, the lender agrees to lend a maximum amount within an agreed term rather than giving the entire sum up front. The borrower makes payment of the principal and interest only on the amount borrowed.
An auto loan is a kind of secured loan used to purchase an automobile. Similar to the mortgage, the lender gives you sufficient funds to immediately get hold of the car you want to purchase. Auto loans are amortized, which means you pay off debt with a fixed repayment schedules in regular installments over a specific term. A lien is placed on the car until all your debts have been paid. Defaulting on an auto loan may end up with the bank, repossessing your car.
A title loan is a short-term loan that allows the borrower to use the title of their vehicle as a collateral. As a borrower, you authorize the lender to place a lien on your car title and temporarily surrender the hard copy of your title in exchange for a loan amount. The amount you can borrow is determined by your vehicle’s value, the amount of cash you need, and your ability to repay. Just like in home loans, the lender can repossess the vehicle and sell it to repay the debt if the borrower defaults.
- Unsecured Loans
A credit card is a widely accepted loan in a form of a payment card used to buy goods and services which will be repaid at a later date. Credit cards are convenient substitutes for cash or check. You can use the card for any purpose, from buying groceries to paying college tuition. Just keep in mind that you have a credit limit approved by an issuer such as a bank, and you must pay for the credit card purchases within 30 days of purchase. Failing to do so may result in penalties and interest rates increase.
As the term implies, a student loan is a form of financial aid designed to assist a person in funding his educational needs, from books and school supplies to tuition fees. Compared to other types of loans, the interest rates on student loans are lower and the repayment may be postponed while the student is still in school. To ensure the customer can repay the loan, some student loan programs require the borrower to have a guarantor or cosigner who will keep up with the repayment term in the event the borrower is unable to pay for it.
A signature loan also called a “character loan” is a kind of personal loan that uses only the borrower’s signature and promise to pay as collateral. A solid credit history, as well as sufficient income, are required in acquiring this type of loan. In some cases, the lender may also ask for a co-signer who signs a promissory note and who is called upon when the original lender defaults. Signature loans can be used for any purpose but since it requires no tangible collateral, the interest rates may be higher.
Personal Line Of Credit (LOC)
In a line of credit, the financial institution, usually a bank, permits the customer to borrow a maximum loan balance that he can access at any time. It is a type of a revolving account, wherein the borrower can spend the amount, repay it, and spend it again. A line of credit is flexible. Borrowers can request a certain amount to cater their needs and they only have to pay interest on the amount they spent. As long as he does not exceed the maximum balance set in the agreement, the amount may be used for anything.
- Payday Loans: A privilege or a menace?
A Payday Loan, also referred to as cash advance loan or check advance, is new to the lending scene. It is a short-term loan, categorized as a type of unsecured debt, which is backed by the borrower’s next paycheck. The borrower usually issues a post-dated check in the amount they wish to borrow plus a finance charge in exchange for fast cash. The amount will be automatically cashed out by the lender, typically a private company, upon agreed date, commonly the next payday.
Companies that offer payday loans have already developed a bad reputation for their predatory lending practices. The biggest pitfall of these loans is their high annual percentage rates (APRs) which might be difficult to pay off. For instance, if you’ll borrow $100 for a week, you’ll pay another $17.50 for the fee, which translates into an interest rate of more than 900% on a yearly basis.
Another concern is the borrowers, who usually have bad credit and low incomes, are forced to use payday loans as a borrowing alternative since they have no access to credit cards and traditional deposit bank account. Although the amounts only range from $100 to $1,500 for 30 days or less, the payment can still get out of hand, especially for individuals with no stable income. Aside from facing default charges, the lender might garnish wages and collect payment directly from the bank account if the borrower defaults.
Despite for these disadvantages, there are a huge number of customers from Australia, UK, Canada, and U.S. who patronize payday loans primarily because of the benefits that may overweigh the downfalls. Given that it is designed to meet the needs of consumers when emergency situations arise, qualifying for payday loans is pretty easy. It is also fast and convenient since it usually takes just a few minutes before your borrowed money gets the hands of the customer. Lastly, the amount the customer can borrow is limited only to his income so it will be easier for him to pay back debts when they are due.
Five-Way Etiquette For Responsible Borrowers
Smart tips in borrowing
- Understanding the basics of the loan
The first step in applying for a loan is determining how much you need to borrow as well as the reason for having such loans. Then, compare the different kinds of loans and lending options. Are these loans short-term or long-term? Do they require a collateral or an over the top credit history? What are the risks if you default? Determine what kind of loan is suitable for your budget and needs.
Know the advantages and disadvantages of these loans as well as the maximum and minimum amount you can borrow from these loans. Keep in mind that all loans are subject to interest so you may try to borrow the least amount possible and use some of your savings to reduce the amount you need to borrow.
- Qualifying for the loan
After determining the basics of the type of loan you’re applying for, you should also assess yourself. To help you with that, here are three questions that may determine if you are qualified for the loan.
Are you creditworthy?
Check your credit score to determine your eligibility. As discussed in the previous parts of this article, the approval for unsecured loans is primarily based on the borrower’s credit file. You may request a credit report from a bank or credit issuing company you made transactions with recently.
Good credit: 700.
Fair credit: between 650 and 699.
Poor credit: anything below 649.
Before going for another loan, it will be better if you’ll pay down other balances you have on your credit card and other loans. Try to reduce your overall debt to improve your credit score and debt to income ratio. If possible, pay your balances in full to avoid unnecessary charges and interest rates.
Do you have a valuable collateral?
It is quite difficult to get a loan if your credit score is below 649. This will lead you to secured loans. Determine what assets you will offer as a collateral. It could be your home, car, certificate of deposit, or personal savings. An authorized person from the bank will appraise your property.
Can you commit?
Try to make a list of all your expenses and debts versus your monthly income. Have a room for additonal monthly payment toward your loan and determine if you can keep up with the terms of the loan before signing the agreement.
- Choosing your lenders wisely
There are two types of lenders – the one who will make the loan work for you and the one who will make the loan work against you. Go for the reputable, state-licensed financial institutions with a solid reputation and impressive history. They may be demanding with qualifications but they will give you the best experience possible if you comply well with their requirements and the terms of agreement.
If you have a good credit
Apply for a loan from a bank or credit union with whom you already have an established relationship. You are likely to get approved because they already know your spending habits, sources of income, and credit history. As a patron of that bank, you may also get qualified for a low-interest rate.
However, if there are better options offered by other banks, don’t hesitate to settle for it. Contact various lenders and ask for their minimum credit score requirements and their interest rates.
If you have a bad credit score
Most private lending companies, usually online, cater to individuals with a lower credit score. They have lower operating costs and faster transactions compared to financial institutions. Just keep in mind that the interest rate they offer will still be based on your credit score: the lower your credit score, the higher your interest rates may be.
Don’t get tempted by lenders who assure you a loan immediately despite your poor credit rating. Try to do a background check before signing up for a loan. Also, be mindful of loan scams, such as an advanced fee loan scam wherein you are asked of an insurance fee up front before sending your borrowed money.
- Submitting your application
Loans cater to different needs and in line with this, they often have different requirements too. Some prerequisites also differ per on the country or state. However, the major requirements for most loans have something in common. Here are some of them.
Proof of identity
Firstly, you should be between 18 and 80 years old, except for student loans. You should also provide your social security number and present government IDs like a passport, driver’s license, and birth certificate.
Confirmation of your living address
You should provide utility bills, credit card bills, a copy of your lease, or other documents that confirm your present address.
Verification of your income
Lenders would want to find out your current income to assure them whether you can commit in repaying the loan. With this, they may require you to provide copies of your payroll advice for the past 30 days as well as tax records.
Information about any other current debt
Lenders would also want to know if you have other debts and may require you to provide copies of credit card bills and other proof of debt obligations.
Information about the amount you want to borrow
Aside from knowing how much the amount is, you should tell your lender where will you use it for and how will you spend it.
- Repaying your loan
Staying true to your word might be one of the hardest parts of borrowing. In repaying your loan, you are not just paying for today but for the future. You are creating your credit history and any delinquent actions you commit may hurt your chance of getting a loan in the succeeding months or years. So start clean and be a responsible payer.
Know your options for repayment
Determine if you have better options by discussing the matter with your lender. Do they accept balloon payments or interest-only loans? Are they open to refinancing? Do they charge for prepayments? Compare these options and the penalties and charges you might face then choose the one that best fits your needs.
Hit your deadlines
Pay according to the agreement set forth by your lender. Try to avoid late fees. It doesn’t only hurt your budget but results in credit rating downgrade as well.
Stay on track with the lender
Pay attention to the notices and paperworks your lender presents you. If you’re having a hard time keeping up with your monthly payments, don’t hide inside your closet and skip the deadline. Talk to your lender directly and negotiate. You might as well develop a repayment plan that would benefit both parties.