The Difference between Unsecured and Secured Loans
Before discussing the differences between secured and unsecured loans, it’s important to take a look at loan options based on credit rating. In 1956, Fair Isaac and Company created FICO algorithm to determine how risky it would be to lend money to certain people. The exact algorithm isn’t publicly known for proprietary reasons. However, five specific categories make up the numbers determining a good score from a bad one. The categories include:
• Types of credit in use
• Payment history
• Amount of money owed
• New credit
• Length of credit history
Based on these categories scores range from 300 to 850. The higher the score, the better the chances of obtaining a loan and better interest rate. However; there are also bad credit loans to help people to improve their credit score.
Credit Impact on Loans
When applying for any type of credit, a lender typically pulls a person’s credit history. This history, including credit scores, is available at the three major credit bureaus. Any time a payment is late or missed, it’s reported to the credit bureaus. The more negative items on a person’s report, the lower the FICO score. For example, a homeowner misses one payment, but no history of prior missed payments. Her FICO score take a 100-point drop just for a payment that is 30 days late.
Some negative items like foreclosures and extremely late payments can have an impact on a credit score for at least seven years. In fact, it can take years for a person to fully repair his credit score.
Types of Loans Offered to Borrowers
There are about seven types of loans a borrower can choose. For example, an open-end loan is a credit card or other line of credit. The more money paid on the loan or line of credit the more money a borrower has to spend. However, each time a purchase is made, the credit limit decreases.
Another option is a closed-ended loan. A borrower is allowed to obtain a specific amount and given either at one time or in installments. The loan doesn’t have an available balance. Instead, the borrower pays on the loan until repaid in full.
A conventional loan is a type of mortgage loan. It’s not backed by a government agency, but lenders do follow specific guidelines when lending money.
The other two loan types are similar to a closed-ended loan where the amount is fixed. They are secured and unsecured loans.
The Difference Between Secured and Unsecured Loans
Secured loans are backed by assets. Assets are something of value. Borrowers pledge assets such as a house or vehicle ensure they will repay the loan. This refers to pledging collateral for the loan. By pledging collateral and agreeing to the loan, the lender can take the asset if the loan isn’t repaid. Remember, the asset is taken only if the borrower defaults, or doesn’t repay the loan. The lender takes the asset and sells it to use the proceeds to pay off the secured loan. The borrower is still responsible for any remaining money amount.
Secured loans are given in larger amounts. Thus, the repayment period is longer than an unsecured loan. Typically, loan repayment last from five to 30 years. Also, more interest in paid throughout the life of the loan.