People take out loans for a variety of motives. It could be for expanding their business, to pay for the cost of higher schooling, purchase cars or homes, or to purchase a wedding diamond ring for their girlfriend or spouse.
The majority of loans are classified into two types, secured and unsecured. Let's first learn the definition of a secure loan.
What are Secured Loans?
Secured loans are the ones in which the borrower holds property as a surety or collateral to obtain money. The collateral could be your car or home or anything else that is worth something.
Simply put, should the borrower default the lender may utilize the asset to repay the amount it has lent the creditor.
The most common types of secured loans include auto and mortgage loans which are where the asset being borrowed becomes the collateral for financing. In the case of a car loan in the event that the borrower fails to make the loan, the issuer may take possession of the vehicle.
When a business or an individual obtains a loan and the property that is being financed is used to secure the terms of the loan. In reality, the lending institution holds an equity stake in the home until the mortgage is paid completely. If the borrower fails to make the payment the lender is able to confiscate the property and sell it in order to recover the amount due.
What Are Unsecured Loans?
Let's look at unsecured loans. As opposed to secured loans unsecured loans are not backed by having collateral. If the borrower is in default on this kind of loan then the lender will file an action to recover the money due. A secured loan is based solely on the borrower's creditworthiness and guarantees repayment.
Banks offer a higher rate of interest on loans that are not secured because they carry a high risk. Additionally, credit score and debt-to-income requirements are typically higher for these types of loans.
When they offer loans that are not secured banks look into the credit report of the borrower. Any previous default can cause the being unable to repay the loan. Additionally, the borrower's financial situation is also examined to determine if he can repay the loan.
Examples of unsecured loans include personal loans, education loans, or credit card purchases. If a bank determines that a loan or any outstanding debts are not re-usable and is deemed to be an unworthy loan.
The RBI recently announced in an RTI response that banks had written off an astounding 1168,095 crore of bad loans over the past 10 years. Evidently, the vast majority were unsecured loans.
Those who aren't looking to put their assets up for pledge or do not have a property to qualify for a secured loan can opt for a non-secured loan. It's a great alternative for those seeking immediate cash.
What Are Student Loans?
Federal student loans are available through the Free Application for Federal Student Aid (FAFSA). Parents and students submit their financial details in the application form. It is given to the student's school of preference. The office for financial aid in each institution crunches figures to figure out what (if there's any) assistance the pupil is eligible for and then mails the student the "award letter" filled with all the information regarding their financial aid package.
Note: This aid can be provided in the form of loans for students, but it may be offered in the form of grants and scholarships. That's why I suggest you fill out the FAFSA--just be sure to just accept the cash you receive for free. This is not a loan zone and you should not be a part of it.
Students can apply for private student loans directly through the loan provider. For federal loans and private loans, the applicant must sign the promissory notes (sounds like a nightmare, isn't it?). It's a legal document that states the student is required to pay the loan in addition to interest and also includes all conditions and terms that apply to the loan. It's sort of like a pledge to surrender your rights. It's not exactly a joke, but it is.
However, IRS has programs that are used to give students or guardians relief, you can claim a student loan interest deduction to save up to $2500.
What Is A Personal Loan?
A personal loan is a money borrowed from a lender that you pay back with equal monthly payments, or installments, over a fixed period, typically two to seven years. You can get personal loans from banks, credit unions, and online lenders. You can also use Payday Loan Apps to get instant, interest-free loans.
In return for borrowing, you pay interest on the loan. Interest rates on personal loans range from about 6% to 36%. Borrowers with good to excellent credit (above 690 on the FICO scale) are more likely to qualify and receive a rate at the lower end of that range.
If your credit is bad, you can boost your chances of qualifying by building your credit and reducing your debt. There are some lenders that offer bad credit personal loans but expect higher rates.
When is a personal loan a bad idea?
There are a few instances when it’s better to avoid a personal loan:
It’s a no-credit-check loan: Lenders that don’t check your credit can’t accurately assess your ability to afford the loan. This means more risk for them and much higher interest rates for you. If your credit is bad, but you need to borrow, exhaust all other options first.
Managing debt is tough for you: A debt consolidation loan can ease your debt burden, but it requires that you use the loan to pay off your other debts and avoid taking on any more.
A good first step toward getting better at managing your debt is following a budget that accounts for needs, wants, and debt payments.
You have cheaper alternatives: Even in an emergency, we always recommend taking a moment to consider alternatives to borrowing. If your credit is good, you may qualify for a 0% interest credit card. Medical debt can often be covered with a payment plan. Your employer may offer a cash advance on your paycheck. Take our quiz below to explore alternatives.