Secured loans and unsecured loans have positive and negative aspects both for lender and borrower. What are some of these aspects? What is the difference between a secured loan and an unsecured loan?
A secured loan is one in which the money borrowed is guaranteed to be repaid or some asset will be forfeited. The most common example is a home loan. The borrower agrees to repay on the terms of the contract, and if he or she defaults, the lender can legally claim the home as compensation.
This is serious because it means if you default on even one payment the lender can take your home in foreclosure and sell it for payment of the debt. In reality, the lender would not take such aggressive action after only one missed payment. The foreclosure and sale of a home is a long and costly process that lenders try to avoid if at all possible.
The truth is that lenders will wait a long time before resorting to foreclosure. Even after several months of default payments the lender will continue to try aggressive demand letters to motivate the Borrower to pay. Even when the real estate market is good for selling homes, lenders would focus their time and resources in other things besides foreclosures and sales.
Nevertheless, it's wise to realize that the lender has this right. How important or not that right is can be judged by recognizing that even with an unsecured loan, creditors have the legal right to seize assets like salary, stocks and property. This requires only undertaking a relatively simple and inexpensive legal procedure to declare the borrower in default.
However, taking legal action is still an expense for the lender and requires some time and effort that they would rather not sacrifice. In most cases, they prefer to work out a payment arrangement.
There are other differences between secured and unsecured loans that borrowers should be aware of. Since the money in an unsecured loan is not, in theory, backed by the right to seize the asset in case of default, the interest rates on them are usually higher.
Since the lender will incur more loss on unsecured loans defaulted on, they make up for this potential loss by charging a higher rate of interest. Sometimes that higher interest rate will encourage borrowers to select a secured loan. Lenders prefer that because the borrower has more incentive to repay the loan when it is attached to their property.
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